By Kim Tong-hyung
Interest-rate setters at the Bank of Korea (BOK) have mostly been on autopilot the past year with a combination of higher prices and subduing economic activity forcing them to sit on their hands.
However, with economic data in recent weeks pointing to easing inflationary pressures, some observers wonder whether the central bank is pondering what would have been unthinkable just a few months ago: lowering borrowing costs and pumping up the money supply.
Shaving the policy rate, which was kept at 3.25 percent for the ninth-consecutive month in March, would be seen by some as an absurd measure in a country where people owe more money than the entire economy generates in a year.
However, it’s also obvious that the Lee Myung-bak government will continue to put growth before price stability as worsening global conditions threaten to derail Korea’s fragile recovery. And with exports taking a hit, policymakers are willing to hang the fate of the economy on households extending their destructive borrow-to-spend behavior.
The BOK provided the latest indicator of easing price pressure Monday, announcing that growth in producer prices had pulled back to its lowest level in nearly two years.
The bank’s producer price index climbed 2.8 percent last month from a year ago, significantly below the annual 3.5 percent growth measured in January. This represented the slowest pace since the 2.6 percent year-on-year growth reported in March 2010, BOK officials said.
The index is regarded as a reliable indicator of changes in consumer prices. And recent government data showed that the country’s consumer price inflation unexpectedly eased for a third straight month to a 20-month low of 2.6 percent in March.
The easing of inflationary pressure may allow the BOK to be more aggressive in injecting new life into the economy, according to one senior researcher at a government-run think tank.
“It’s plain as a pikestaff that the country will experience a sharp pullback in its trade surplus this year, so preventing the economy from stalling will depend on how policymakers manage to fire up the domestic economy,” he said.
“Of course, the greatest way to boost domestic demand is to elevate income levels, improve employment and restore stability. However, these are difficult goals that would take time. Cutting interest rates provides a quicker way to spark changes and those are the options that politicians will like better.”
Keeping borrowing costs below the rate of inflation, which ended 2011 at 4 percent, has been an uncomfortable position for the bank, which under the reign of Governor Kim Choong-soo, has been facing mounting criticism that it’s perverting the principles of sound money. And the volatility in international oil prices is raising concerns that inflation could peak again on higher household bills for fuel.
Shin Byeong-ghil, a researcher from Solomon Investment and Securities, nonetheless believes that the case for the BOK to cut rates is building as economic activity continues to be weak, soft and subdued.
A report by the Ministry of Knowledge Economy Ministry earlier this month unveiled a sharp pullback in the country’s trade surplus during March, confirming that dismal global conditions are hitting exporters in the back of their heads.
Consumers are unready to pick up the slack as their savings and spending capabilities have been severely damaged by personal indebtedness, stagnant income and inflation. At around one quadrillion won, the country’s household debt mountain now matches an entire year’s gross domestic product.
“It’s clearly that the inflationary pressures are easing a lot faster than we thought. While BOK has been more worried about the month-to-month trends in consumer prices rather than the year-on-year comparisons, the recent figures show that the level of prices has been declining on the monthly basis as well,” said Shin, who forecasted the bank to cut the policy rate once or twice until the end of the year.
“Aside of the higher oil prices, there aren’t many factors that could seriously disturb price stability. The easing inflationary pressures will improve demand and inject new life into economic activity and the BOK could help this momentum with moderate changes to the policy rate.”
So while the weakening price pressures may give Kim and the member of his monetary policy committee more options in monetary decisions, it bears further watching whether they will be willing to use them.
Besides, this is an election year, when the public’s discontent over anything and everything gets drummed up by competing politicians and the hungry media wolves.
Lowering interest rates, which would trigger all sorts of questions about BOK’s commitment to control the costs of living, would require boldness and decisiveness. And these are two qualities Kim has never been accused of displaying in his two years as the country’s top central banker.
Lim Hee-jeong, an economist at the Hyundai Research Institute, wonders whether lowering interest rates would work as prescribed when official data shows that the lack of liquidity was never the problem.
“We have liquidity now, but the money is staying with financial institutions and not flowing to places where they could help this economy. So it would be absurd to think that we could solve this lack of flow by jacking up the money supply.
“When eliminating the base effect caused from the outrageous price levels of last year, it could be said that the inflationary pressures remain rather high. The elevation in fuel prices and the continuously high levels of inflation expectations could make a rate cut a dangerous move,” he said.