CONTRIBUTION Contingency plan needed against 'global 3 highs'

Recently, the rise in interest rates has caused alarm. The U.S. 10-year treasury yield has hit 4.88 percent, recording the highest level in 16 years, and an expectation for a rise is increasing as the Korean 3-year treasury yield also exceeds 4 percent.

Inflation, interest rates and exchange rates have been increasing again since September, causing a comprehensive contraction in global economic and international financial market conditions, and fueling concerns about a combined crisis in both the real economy and financial sector.

First, on inflation. The consumer price index in September has risen by 3.7 percent compared to a year ago, recording 3 percent increases consecutively for the past two months due to recent international oil price hikes. Consumer prices, which had remained in the zero percent range in 2020, jumped to the 5 percent range this January for the first time in about 20 years due to the global supply chain collapse caused by the COVID-19 pandemic. It is expected that such high prices will not easily decrease because they are driven by the shortage of global commodities such as oil and grains.

Second, on high interest rates. Central banks around the world, including the United States, have aggressively raised interest rates in order to tame soaring inflation. The possibility of maintaining or further raising these high-interest rates remains. The labor market continues to show strong recovery despite the U.S. Federal Reserve, which determines the direction of global interest rates, implementing 18 months of contractionary monetary policy.

The possibility of a 0.25 percentage point rate hike at the upcoming December FOMC Meeting is gradually increasing, confirming the "higher for longer" policy. South Korea is facing a difficult situation where it is not easy to raise interest rates due to sluggish exports and consumption market conditions. It also does not help that South Korea has the highest household debt level among OECD countries.

Finally, high exchange rates. The Korean won-to-dollar exchange rate, which was 1,260 won per dollar in July, is now hovering around 1,350 won, reaching its highest level in 11 months. If this trend continues, it is expected to reach 1,400 won by the end of this year. For South Korea, where exports are the foundation of the economy, a rising exchange rate can be a significant boost.

However, the exchange rates of our export competitors have also increased significantly. For example, since the beginning of this year, the Japanese yen has depreciated by 15 percent. As a result, the increase in the won-to-dollar exchange rate alone is not providing the needed competitive boost to our export products. In addition, as we rely on imported parts to export finished products, the rising exchange rate is increasing our cost burden and reducing profit margins.

This "global 3 highs" phenomenon of inflation, interest rates and exchange rates is expected to persist for a considerable period, negatively impacting households and corporations. According to a report by the Bank of Korea, the household debt-to-GDP ratio in South Korea reached 101.7 percent in the second quarter. Especially, with mortgage loans exceeding 700 trillion won (518.5 billion dollars) and interest rates surpassing 7 percent, further increases in interest rates and declines in housing prices would not only affect the real estate market but also the financial system.

Corporate debt has also increased, recording 124.1 percent of GDP, higher than the 113.6 percent during the 1997 foreign exchange crisis and the 99.6 percent of the global financial crisis in 2008. The bond market is in a state of near panic, particularly with corporate bond rates surging, causing three-year AA-rated corporate bond rates to exceed 4.8 percent.

Therefore, households and businesses need to reduce debt and strengthen their resilience through bold restructuring. It is also a crucial moment for policymakers to proactively manage financial risks in preparation for a potential perfect storm. Economic and financial crises tend to occur in cycles of 10 or 20 years. It is a time that requires wisdom to learn from the past and manage risks during crises. Rather than going against the trend, it is necessary to adapt and prepare contingency plans.

The writer is a senior consultant and auditor of Franklin Templeton Investments Korea, where he previously worked as CEO, and is a professor of the University of Maryland Global Campus' MBA program.