Belated Action
Central Bank Must Take Preemptive Measures for Financial Stability
Thursday’s interest rate hike is seen as the central bank’s efforts to curb the excessive supply of money and reign in the speculative mood on the Seoul stock market. The Bank of Korea (BOK) raised the overnight call rate by 0.25 percentage points to a six-year-high of 5 percent. The action followed the rate increase in July. It is unusual that the BOK ratcheted up the rate for two months in a row.
Monetary policymakers, economists and market players have expressed concerns about the excess liquidity that has been blamed for property speculation over the past years. The overheated real estate market began to cool down this year due to strong anti-speculation measures, including heavier property and capital gains taxes. However, an astronomical amount of superfluous money has recently flown into the local stock exchange, raising worries about a bubble.
Despite the previous month’s rate increase, the composite stock price index KOSPI hit a record high of 2004.22 on July 25. As the index rose above the 2000-point mark, many investors and analysts painted a rosy picture. They must have missed a crucial point _ what has driven the market to such an unusual strong rally? The answer is simple. It is because of excess liquidity. Investors are even rushing to get bank loans to buy up stocks in the hope of windfalls.
It is fortunate that the market is now undergoing a brief correctional period. Share prices once fell below the 1900-mark. But, the KOSPI rebounded to 1908.68 Thursday, boosted by Wednesday’s announcement of a second inter-Korean summit scheduled for Aug. 28-30 in Pyongyang. In this situation, the BOK has come to tighten its monetary policy by increasing the short-term inter-bank rate.
Some market watchers had predicted that the central bank might freeze the rate at the current level. They cite worries about a credit pinch following the ripples in the U.S. sub-prime mortgage crisis and downward pressure on the Korean equity market. However, the BOK downplayed such worries as the market showed a strong rebound thanks to the planned South-North summit. Finally, monetary policymakers concluded that they could no longer overlook the worsening problem of excess liquidity.
According to the BOK, the aggregate supply of money rose by 1.8 percent or 34.9 trillion won to 1,950 trillion won in June from the previous month. The pace of the growth is alarming. The rapid growth of the money supply is feared to put strong inflationary pressure on consumer prices, stoke speculation and impede stable economic growth. The central bank will have to further tighten the money supply in case such fears show signs of becoming a reality. However, the BOK hinted that it would not raise the call rate any more by then end of this year.
The BOK is under criticism for failing to make a timely rate hike. Experts pointed out that the central bank should have increased the interest rate in advance to effectively reduce excess liquidity. However, the BOK did nothing for about 10 months until July although there were alarming signs of speculation. Central bank officials must keep in mind that belated action has little effect on the market. Do they really believe that the latest action is enough to cut excess liquidity, check rising inflationary pressure and ensure economic stability?