Concerns Over Growth Rate Decline Amid Austerity... Companies Face "Double Burden of Rising Production Costs and Interest Expenses"

Big Step by Monetary Policy Committee Possible to Stabilize Prices and Foreign Exchange Market
US-Korea Policy Rate Inversion as Early as Late July...Growth Rate Slowdown Inevitable

Source=Korea Chamber of Commerce and Industry

[Asia Economy Reporter Jeong Dong-hoon] As the policy interest rate inversion between South Korea and the United States approaches, there are forecasts that if the Bank of Korea's Monetary Policy Committee (MPC) takes a 'big step' (raising the base interest rate by 0.5 percentage points) in July, the burden on companies already struggling due to rising production costs and economic contraction will increase.

The Korea Chamber of Commerce and Industry's SGI (Sustainable Growth Initiative) stated in its July 11 report titled "The Arrival and Implications of the Korea-US Policy Interest Rate Inversion" that "there is a possibility that the Korea-US policy interest rates will invert as early as the end of July," adding, "Although the hike is inevitable to stabilize the soaring domestic inflation and foreign exchange market, urgent preparation is needed as the impact on companies and households is expected to be significant."

SGI further noted, "The interest rate inversion itself does not necessarily have a negative impact on the domestic economy, but given the expanding external economic risks such as China's growth slowdown and the prolonged Ukraine war, the pain could be greater than in the past." SGI explained that policies to ease tax burdens, such as corporate tax cuts, along with measures to moderate the pace of interest rate hikes, are necessary to help companies weakened by rising raw material prices and wage pressures endure.

Companies Face Double Hardship as Interest Burden Rises Alongside Increased Production Costs

SGI identified short-term economic contraction, increased corporate financial burdens, and foreign capital outflows as key factors to watch when domestic policy interest rates change.

First, the report assessed the possibility of short-term economic contraction. According to SGI's analysis, raising policy interest rates to reduce inflation requires some sacrifice in economic growth rate, known as the "sacrifice ratio." This refers to the cost of growth loss accompanying a decline in inflation.

Based on past periods of inflation slowdown, SGI's research found that to reduce the inflation rate by 1 percentage point, the economic growth rate must be sacrificed by up to 0.96%. This is somewhat higher than the average sacrifice ratio of major advanced countries (0.6 to 0.8), indicating that the domestic economy reacts more sensitively to interest rate hikes.

Next, SGI expressed concerns about increased corporate financial burdens due to interest rate hikes. It pointed out that since COVID-19, "the number of marginal companies unable to cover even interest expenses with operating profits has significantly increased." In fact, the proportion of marginal companies in South Korea last year was 16%, about 3.6 percentage points higher than 12.4% in 2019 before the COVID-19 crisis.

The report added, "If the Bank of Korea takes a big step, the scale of corporate loan interest burdens will increase by approximately 3.9 trillion won," analyzing that companies accustomed to prolonged low interest rates and not yet recovered from the COVID-19 shock could be significantly affected if corporate loan interest rates rise.

It particularly predicted that the impact of interest rate hikes would be greater on small and medium-sized enterprises (SMEs) than on large corporations. The report expressed concern, stating, "SMEs have smaller sales volumes and lower credit ratings, so they rely heavily on bank loans rather than issuing stocks or bonds for financing," and "With a 0.5 percentage point increase in the base interest rate, the burden will increase by 1.1 trillion won for large corporations and 2.8 trillion won for SMEs."

Foreign capital outflow possibilities were also considered. The report explained, "Looking at past periods of Korea-US policy interest rate inversion, even when the interest rate differential narrowed or inverted, foreign capital inflows were centered on bonds," adding, "Foreign capital is determined by various factors beyond interest rate levels between the two countries, including exchange rates and domestic economic fundamentals."

However, SGI advised, "Currently, the rapid pace of U.S. interest rate hikes and expectations of won depreciation make the possibility of foreign capital outflows higher than during previous Korea-US policy interest rate inversion periods," and recommended, "Management is needed to prevent negative impacts on finance and the real economy from sudden foreign capital outflows."

Companies Call for Supplementary Measures... Easing Corporate Financial and Tax Burdens, Preparing for Sudden Capital Outflows, and Expanding Growth Engines

While price stability is the most important issue in the domestic economy, concerns have been raised that policies aimed at lowering inflation could exacerbate side effects such as economic slowdown and increased household and corporate debt risks. Accordingly, additional policy measures beyond monetary policy are needed to ensure macroeconomic and financial stability.

The report also proposed easing corporate financial and tax burdens as one of the policy supplements. SGI expressed concern, stating, "Recently, companies have not been able to fully pass on rising raw material costs to sales prices, and if interest burdens also increase, difficulties will intensify." According to a Korea Chamber of Commerce and Industry survey, only 15.8% of companies have sufficiently reflected raw material price increases in product prices.

It further argued, "Considering companies' resilience when policy interest rates change, the pace of hikes should be moderated, and additional government financial support measures such as loan maturity extensions and repayment deferrals for vulnerable SMEs should continue," adding, "Corporate tax rates, which are higher than in major countries, should be reduced, and taxes that hinder investment and win-win cooperation should be abolished to ease corporate tax burdens."

It also called for preparation against sudden foreign capital outflows. "If the rapid U.S. policy interest rate hikes and weakening domestic economic fundamentals occur simultaneously, the possibility of foreign investor capital outflows increases," and suggested, "It is necessary to check whether foreign exchange reserves are sufficient and to block financial instability risks through efforts to maintain foreign exchange soundness, such as expanding currency swaps."

Finally, the need to expand growth engines was emphasized. SGI stated, "The domestic economy faces the challenge of not only stabilizing prices and responding to short-term economic downturns but also raising growth potential in the medium to long term," adding, "Due to demographic changes, the domestic potential growth rate is expected to decline from 2% last year to 1.5% by 2030, so it is necessary to mitigate the negative effects of interest rate hikes through medium- to long-term growth policies."

To this end, SGI said, "A comprehensive transformation of the regulatory system is needed to allow companies, which know future new industries and technological innovations best, to move agilely," and "It is urgent to establish incentive systems and strengthen government financial support so that companies perceive changing global trends, such as the carbon-neutral transition, as opportunities rather than crises."

Kim Cheon-gu, SGI Research Fellow at the Korea Chamber of Commerce and Industry, said, "Raising the base interest rate has extensive and long-term effects on the overall economy," and added, "To mitigate the negative effects of monetary policy, it is necessary to comprehensively review various policies, including accurate economic diagnosis, adjusting the pace of interest rate hikes considering economic agents' resilience, and expanding future growth engines."

This content was produced with the assistance of AI translation services.