[Insight & Opinion] Urgent Measures Needed to Address Delayed US Rate Cut

The timing of the US interest rate cut is a matter of utmost concern not only for the Korean economy but also for the global economy. The anticipated timing of the US rate cut, discussed since last year, continues to be delayed this year as well. Recently, Wall Street has raised speculation about a rate cut in September, but members of the US Federal Open Market Committee (FOMC) project one rate cut by the end of this year according to the dot plot. However, since US inflation remains in the 3% range and the economy is maintaining a boom, the actual timing of the rate cut may be later than expected.

If the US rate cut is delayed, the timing of Korea's rate cut will also be postponed, raising concerns about the growing side effects of sustained high interest rates. Although growth rates are being revised upward due to increased exports, domestic demand is further contracting, exacerbating difficulties in the livelihoods of small business owners and the general public. Additionally, increased interest burdens from high interest rates raise concerns about defaults in real estate project financing (PF), as well as higher delinquency rates among small business owners, small merchants, and household debt, which could lead to credit crunches. Urgent and proactive government measures are needed.

First, early rate cuts should be considered. The Bank of Korea worries about inflation recurrence due to unstable oil prices and exchange rates, and fears capital outflows and exchange rate rises caused by widening interest rate differentials with the US if it cuts rates before the US does. However, inflation in June dropped to 2.4%, and foreign exchange reserves decreased by only $600 million, so the exchange rate is expected to remain stable. If this trend continues, early rate cuts would be desirable as they could significantly mitigate financial distress and domestic demand contraction, maximizing the benefits of the rate cut.

Next, fiscal spending needs to be increased to stimulate domestic demand. The longer the US rate cut is delayed, the more the strong dollar will lower the value of the Korean won, raising the exchange rate and potentially fueling inflation. Therefore, if early rate cuts become difficult, expanding fiscal spending is necessary to stimulate domestic demand and alleviate the hardships of small merchants. Last year, the fiscal deficit accounted for 3.9% of GDP, which is higher than the 3% benchmark, but considering the economic downturn caused by the COVID-19 pandemic and comparing it with the national debt levels of the US and Japan, fiscal soundness is still relatively good. The government should temporarily increase fiscal spending to revive the domestic economy, which is stagnating due to sustained high interest rates, and prevent the expansion of financial distress.

Finally, caution is needed in sharply reducing loan limits. To respond to the rapidly increasing household debt, the government plans to implement the second phase of the Debt Service Ratio (DSR) stress test from September to reduce loan limits. However, with high interest rates, domestic demand contraction, and reduced loan limits, delinquency rates among small business owners and small merchants are expected to rise further. Although the increase in household debt is concerning, it is preferable to postpone the reduction of loan limits until domestic demand recovers to ease the difficulties faced by small business owners and merchants. Additionally, expanding financial and tax support policies for small merchants is also necessary.

On the surface, macroeconomic indicators suggest that the Korean economy is not facing major problems. This year's growth rate has been revised upward to 2.6%, inflation is stabilizing in the mid-2% range, and a current account surplus of over $60 billion is expected. However, a closer look reveals many inherent risks. The exchange rate is nearly 40% higher than before the rate hikes, increasing import prices and the cost of agricultural products, thereby raising the perceived inflation rate. Excessive taxes and high interest burdens are reducing consumer spending power, and financial distress is increasing. The competitiveness of key industries such as shipbuilding, steel, and electronics is weakening, leading to reduced exports to China and fewer jobs. The longer the US rate cut is delayed, the more these problems will worsen due to sustained high interest rates, exposing the Korean economy to crisis risks. Proactive policy responses are urgently needed to mitigate the side effects of the delayed US rate cut.

Kim Jeongsik, Professor Emeritus, Department of Economics, Yonsei University

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