Inflation, exchange rate pose dilemma on economic policies
A record-high KOSPI index is not relevant to most ordinary citizens who are overwhelmed by soaring prices of everyday goods and services.
Food and fuel prices have risen in double digits this year in line with the surge in global commodities prices. The International Monetary Fund (IMF) has warned that inflation for the whole year would be around 4.5 percent, while the government and the Bank of Korea believe, or pretend to believe, that they can control it below 4 percent.
Rhee Chang-yong, the chief economist at the Asian Development Bank, said last Wednesday that the real interest rate has turned negative in many Asian countries including Korea. This means that when money is saved in the bank, its actual value (purchasing power) will decrease day by day ― a situation that no one wants to live with.
To turn the real interest rate positive, raising the interest rate and taming inflation should be done simultaneously. But neither looks easy.
Last Wednesday, lawmakers had the chance to grill the government on this. Facing them were the top economic policymakers _ Yoon Jeung-hyun, the minister of strategy and finance; Kim Choong-soo, the Bank of Korea (BOK) governor; and Shin Je-yoon, the vice chairman of the Financial Services Commission.
Yoon defended the government, saying it can’t control global commodities prices. Domestic inflation can be eased if the Korean won becomes stronger against the dollar (as it has been since March), but rising oil prices are more than enough to offset the benefits from the appreciation, he argued.
Furthermore, firms that export cars, electronic devices and ships complain that the won is already too strong, making it more difficult to compete on the global market against firms from China and elsewhere. A lawmaker echoed this view, claiming that Samsung Electronics, the largest Korean exporter, is expected to lose 300 billion won in profit for every 1 percent appreciation of the won against the dollar.
This means that the finance ministry is stuck in between contradicting interests of exporters and consumers regarding its exchange rate control. The remaining tool is the monetary policy of the central bank. BOK governor Kim, however, is criticized by many for not raising the bank’s key interest rates fast enough. During the National Assembly hearing, a lawmaker from opposition Democratic Party even urged him to consider resigning if the result of his monetary policy turns out nasty.
Kim didn’t look happy to hear that.
“I don’t agree with people who say that I am late in raising the interest rates. It’s what they believe, not what I believe. I think the BOK did reasonably well. Only time will tell who was right,” he said.
Kim said that the IMF scenario of 4.5 percent inflation can be avoided without rapidly raising the interest rate. Rhee, the ADB economist, agrees that the IMF view has not considered the Korean government’s ability and willingness to control prices. He says that the ADB’s forecast is 3.5 percent.
Regardless of who is right, it is unfair to blame the central bank alone for high inflation. Most economists surveyed by BusinessFocus say that inflation is the number one concern for the Korean economy and its root cause is oil prices, not the BOK’s monetary policy.
Korea imports not only oil but almost all key natural resources such as oil, iron, coal and natural gas. And high commodities prices have a ripple effect on the whole economy. Last week POSCO, the largest steel mill, raised prices of its core products by around 15 percent. Shipbuilders and carmakers are braced for the subsequent rise in raw material and parts.
The economy is also heavily dependent on exports. Luckily for exporters, the economic recovery in the U.S. and elsewhere has helped so far. In March, both exports and imports increased by almost 30 percent compared to a year ago.
But things can change fast if the global growth slows. Policymakers will have to pray that does not happen soon, with big elections to be held next year.