By Kang Seung-woo
Staff reporter
A key rate hike and prolonged slump in the real estate market will be major stumbling blocks to Korea's economic recovery in the second half of the year, according to the nation's financial watchdog, Wednesday.
The Financial Supervisory Service (FSS) said that on top of external woes, Asia's fourth largest economy is surrounded by a number of downside risks at home, such as a possible rate increase and the struggling real estate market.
"A hike in the policy rate is forecast to bring about the same for local banks' rates, which will increase the debt-servicing burden on the household sector," an FSS official said. "Eventually, it will affect domestic demand and financial soundness."
The concern comes amid growing calls for a rate increase to curb inflation. The Bank of Korea (BOK) has kept its key interest rate on hold at an all-time low of 2 percent for a 16th month despite fears of increasing inflationary pressure and asset price bubbles.
The construction industry has yet to see signs of a recovery since the property boom in 2005.
As a result, construction firms have failed to pay back project financing loans and the government decided to spend 2.8 trillion won ($2.33 billion) in taxpayers' money to support savings banks saddled with the soured construction loans.
The FSS said that it is not likely that housing prices to suddenly go into a tailspin, but a recent fall, ignited by a growing number of unsold apartments, could last longer than expected.
It said that an unstable cash flow and long-standing geopolitical issues could also drag the nation's rebound.
"The eurozone's financial crisis can affect foreign investor confidence, as it did in the first half," the official said.
"In addition, unexpected action from North Korea could serve as an immediate threat to the financial market."
The FSS pinpointed the lingering sovereign-debt crisis in Europe as the main external risk to the local economy.
"If European banks retrieve loans from the emerging markets as part of restructuring debts of fiscally-hit countries, local banks are likely to have difficulty raising foreign currency funds," he said.
"A scramble for safer assets can also make the market vulnerable."
The appreciation of the Chinese yuan and a delay in regulatory reform are also risky.
China's end to the currency peg with the U.S. dollar two weeks ago could increase inflationary pressure due to a possible rise in its export prices, while a delay in reforming regulations may continue to encourage financial firms to engage in high-risk and high-return business strategies.