By Kim Jae-kyoung
Staff reporter
The government's latest economic forecast indicates that the Korean economy has recovered to its potential growth level and has entered a phase of sustainable economic recovery.
In addition, the upbeat outlook suggests that Asia's fourth largest economy is taking one step closer to the full-fledged exit strategy, solidifying market belief that the central bank will raise interest rates in the coming months.
Growing expectation over rate hikes was further buttressed by the central bank's measure Thursday to lower the ceiling on soft loans to small firms for the third quarter as part of efforts to normalize emergency steps.
"Although there are risks of GDP growth slowing to a moderate pace in the second half, the latest economic outlook by the finance ministry shows that the economy has regained its growth potential," Samsung Economic Research Institute senior economist Kwon Soon-woo said.
"Taking into consideration the upbeat outlook and the central bank's measures, it is moving toward rate hikes," he added.
The Ministry of Strategy and Finance forecast Thursday that the economy will grow 5.8 percent this year, sharply revising upward its earlier growth forecast to reflect the fast-rebounding latest economic indicators.
The ministry expected the nation's gross domestic product to expand 4.5 percent during the second half of the year after 8.1 percent and 6.3 percent on-year advances in the first and second quarters. For 2011, it predicted a 5-percent growth.
On top of a series of optimistic data and outlooks, delicate changes in key economic policymakers' analysis of the economy are taken as signs that the government will shift the focus of its economic policies from growth to price stability.
On Monday, Bank of Korea (BOK) Governor Kim Choong-soo said that the prolonged low interest rates risk sparking inflation and a hike in asset prices.
"The BOK plans to manage the monetary policy in a way to help support the solid growth on the foundation of price stability. If the current accommodative policy stance is prolonged, it could bring about the risks of inflation and a hike in asset prices," he said. This is the first time that the top central banker has mentioned inflation risks.
Strategy and Finance Minister Yoon Jeung-hyun also echoed Kim's view, warning that inflationary pressure is expected to build faster than expected in the second half of this year.
"Korea could face a faster-than-expected price hike in the latter part of this year because the velocity of money circulation is rising and produce prices are also increasing in line with the economic recovery," Yoon said Friday.
The fact that the two policymakers are on the same page over inflation has given an inkling that a key rate increase will come sooner rather than later, given that Yoon has remained very cautious over an early credit tightening.
"Since there is growing upward pressure on consumer prices due to high-flying import prices and an upcoming hike in public services charges, the government cannot focus only on economic growth," a senior BOK official said, asking not to be named.
"Given growing inflationary pressure, the shift in the government's policy stance is deemed a bit late. However, it is a good sign that the finance ministry shares the same view over inflation," he added.
The price for imported goods jumped 2.7 percent in May month-on-month, the biggest monthly jump since it grew 5.1 percent in June 2009 and the fourth consecutive month of increase since February.
The central bank said Thursday that its monetary policy committee decided to cut the cap by 1.5 trillion won ($1.3 billion) to 8.5 trillion won. It raised the cap by a combined 3.5 trillion won to 10 trillion won between October 2008 and March 2009 in a bid to help smaller companies cope with a funding squeeze sparked by the global financial crisis.
The loans, which the BOK extends through commercial banks to small and medium enterprises, carry an annual interest rate of 1.25 percent. The loan cap is determined on a quarterly basis.
The central bank has said that it plans to gradually lower the cap by taking into account financial market conditions, a move aimed at normalizing unconventional measures adopted to fight the financial crisis.
Experts say the move comes as the BOK is mulling the timing of a rate hike amid its head's warning against inflation risks in the second half. "The reduction on the ceiling on soft loans to small firms is part of exit strategies," Kwon of Samsung said.
A possible rate increase is already priced in the financial market, with yields on bonds rising rapidly over the past month. Market players participated in trading on belief that the central bank will raise key rates in the months to come.
On June 21, yields on three-year state bonds jumped by 16 basis points, while those on three year corporate bonds with AA minus rose by 13 basis points.
"I think that the central bank should have shifted to credit tightening mode earlier. Since market interest rates have recently risen by more than 20 basis points, a 25 basis point rate hike is not likely to affect the financial market," the BOK official said.
Despite the upbeat outlook, many analysts said that the government and the central bank should pursue exit strategies in a very sophisticated manner as there are lingering uncertainties overhanging the economy, such as the European debt crisis and troubled construction sector.
"The Korean economy is exposed to a number of downside risks both at home and abroad. On the external side, the ongoing debt crisis in Europe and volatile emerging markets are posing the threat," Kwon said.
"On the domestic side, a sluggish real estate market and troubled builders are emerging as the big hurdles to the economic recovery. If things get worse down the road, the economy will be unable to get back on the path of a full recovery," he added. "If these unfavorable factors are not cleared away soon, the economic growth will lose momentum in the second half of the year."