'Rate cuts not enough to keep economy on track as virus spreads'

Bank of Korea Governor Lee Ju-yeol speaks in a press conference after holding a monetary board meeting at its headquarters in Seoul on Feb. 27. Courtesy of Bank of Korea

By Lee Min-hyung

The Bank of Korea's (BOK) possible 25 basis points cut in its benchmark key rate may not be enough to keep the economy on track, as the spread of the COVID-19 coronavirus, in itself, should never be a determining factor for monetary easing, experts said Sunday.

They said they would not be surprised to see the BOK cutting its rate by even more, within the month at the earliest, with some hawks claiming the bank should slash its rate by a whopping 50 basis points as fears on the epidemic are growing not just here but in other countries.

South Korea has been hit hard by the drastic spread of COVID-19 with confirmed cases surpassing 7,000. Multiple data indicate the epidemic will seriously dampen economic activities, fueling concern that Asia's fourth-largest economy may contract in the first quarter.

The country has joined with other economies which are moving to enact stimulus measures as needed with the rapid spread of the virus causing worries among foreign and local investors as it weighs on the outlook for economic growth. Major investment banks have recently lowered their growth outlooks for the country.

Amid the worsening situation, analysts say the BOK needs to cut its rate by at least 25 basis points to 1 percent by holding an extra monetary board meeting in March before the scheduled one the following month.

But some economists have voiced skepticism, saying the central bank should take multiple factors into consideration before making changes to its monetary policy, rather than being swayed by the coronavirus-driven panic here and abroad. The BOK earlier said it was ready to adjust monetary policy further if required to support economic growth.

The ongoing economic fallout is due to failure in the government's initial responses to prevent the spread of the virus here, said Yonsei University professor Sung Tae-yoon. For this reason, it is best to tackle the virus-related economic issues by using a special budget.

A rate cut is only reasonable if the BOK judges the economic status quo is unlikely to take a turn for the better in the short term due to a structural slowdown, not just the virus factor, Sung added.

A growing number of experts have voiced the need for the rate cut since early last week when the United States Federal Reserve cut its benchmark rate to a range of between 1 and 1.25 percent to minimize economic damage from the virus.

Despite the move by the world's largest economy, the BOK does not have to follow in its footsteps, according to the professor.

He said the key question is whether or not the BOK can address concerns over the efficacy of a rate cut in terms of reacting to the coronavirus outbreak. Thoughts are that unlike the financial crisis more than a decade ago, it's not immediately obvious that the current situation will be alleviated by a further interest rate cut.

Meritz Securities economist Yoon Yeo-sam argues that a rate cut is not a “cure-all” to deal with economic damage from the epidemic. “The government should place an emphasis on coming up with fiscal policies first to actively deal with coronavirus-hit industrial and consumption areas,” he said, adding monetary policies “should come” later.

“We cannot rule out the possibility that it decides to make emergency decisions just like the Fed did,” Yoon at Meritz said.

Last week, BOK Governor Lee Ju-yeol said it would be tough for the central bank to deal with the economic impact from the virus only through monetary policy. He said it would collaborate with other government authorities before taking any necessary steps.

As the BOK governor said, an interest rate cut is unlikely to persuade consumers anxious about contracting the coronavirus to visit shops or spend money at restaurants.

In addition any further rate cut would reduce the cost of borrowing and that could have a negative impact on consumers and companies in terms of financial soundness.

If South Korea keeps its “ultra-low” interest rate, then that could depress profits at local banks as it leads to “margin compression,” narrowing the spread between what banks pay savers and charges borrowers. Also small local companies, in particular, would face cash-flow challenges.

Citing these factors, the Meritz analyst said; “If the epidemic issue is as urgent as the 2008 global financial crisis, we should not take a wait-and-see approach. But this is not the case for now.” But he declined to elaborate on the necessity of the government applying tax cuts.