Keep calm and carry on

By John Burton

Will Korea be the next Asian country after Japan to embark on an unconventional monetary policy to boost the economy? Some are predicting that the Bank of Korea could cut its base rate from the current 1.25% to 0.75% by the first quarter of next year.

Although that falls short of the extreme monetary measures pursued by Japan and the European Central Bank among others as they pump money into the financial system to encourage lending and revitalize growth, slashing interest rates by the BOK could continue if the economy does not recover, some analysts predict.

But others disagree about that gloomy assessment. S&P, the credit rating agency, recently raised its credit rating for Korea. “Although Korea’s GDP growth in the next three to five years will be slower than its growth before the 2008 global financial crisis, we believe its prospects are superior to those of most developed economies,” it said.

A cut in interest rates instead should be seen as a short-term fix to support increased government spending, while weakening the won to promote exports against the backdrop of continued low inflation.

Korea’s economic problems are relatively benign compared to those of Japan, particularly since it has avoided descending into a deflationary spiral. Korea has maintained a track record of steady growth, its government debt is among the lowest in the OECD and it has reduced its exposure to foreign borrowing. The country still faces some challenges. The biggest is a fall in exports, which has contracted from 19 consecutive months, mainly because of sluggish demand in China and Europe.

But there seems little reason for Korea in the future to adopt unconventional monetary policies such as quantitative easing, negative policy interest rates, issuing “forward guidance” on what the central bank will do in the future or resorting to “helicopter money,” the financing of government spending using the central bank’s balance sheet.

S&P, for example, pointed out that Korea’s economic performance in recent years is already stronger than most other advanced economies and it predicts the country’s average GDP per capita will rise to $30,000 in 2019 from $27,000 in 2016, although this figure is flattered somewhat by the fact that the won has strengthened against the dollar.

Nonetheless, cutting interest rates to 0.75% would be the lowest rate in Korea’s history as the government undertakes a restructuring of the shipbuilding and other troubled sectors, which will be largely financed by state-owned banks.

Foreign investors, however, are likely to welcome what they still recognize as a relatively orthodox monetary policy, ensuring them of some certainty in a world where other major markets have resorted to unconventional monetary policies that leave investors puzzled about what will come next.

One of Korea’s chief appeals to foreign investors is that its industries and export markets remain well-diversified. Although export performance has slowed, the same can be said for other Asian economies suffering from weaker global trade. If the U.S. economy continues to recover, demand there would help offset weaker exports to China, which is Korea’s largest export market.

Continued low inflation rates, helped by falling oil prices, will provide the Bank of Korea with ample room to keep cutting interests without fears of stoking inflationary pressure.

The biggest downside to low interests is that it will likely exacerbate growing household debt, which potentially threatens the stability of the financial system. If household debt grows too large, the central bank may decide it cannot ease interest rates further. But it has taken steps to alleviate some of the risks posed by the household sector by encouraging the conversion of variable-rate mortgages to fixed-rate ones to prevent personal bankruptcies once rates start rising again.

While Korea’s current economic prospects are not as dire as they are sometimes portrayed in the media, it still needs to accept the fact that future growth will be modest in line with the trajectory of other advanced economies and as the population ages, the Chinese economy slows and households struggle to pay off high debts.

The biggest threat to Korea’s economic performance in the next few years may well be the impact it will suffer from unconventional monetary policies elsewhere. These policies have already created havoc in terms of making foreign capital flowsmore volatile and causing rapidly fluctuating exchange rates. Korea and other Asian countries saw considerable capital inflows into their economies after 2008 since they were offering higher interest rates than those in the West. This led to the value of Asian currencies rising, which weakened export competitiveness. But the capital flows have since reversed in anticipation of U.S. rate hikes.

What Korea probably has most to fear is what happens when other countries try to abandon their unconventional monetary policies because it could trigger unknown global economic events that could have a disruptive effect on the local economy.

John Burton, a former Korea correspondent for the Financial Times, is now a Seoul-based independent journalist and media consultant. He can be reached at johnburtonft@yahoo.com.atimes.co.kr.