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| A Hana Bank employee counts dollars at the bank's headquarters in downtown Seoul, April 2021. Yonhap |
By Lee Yeon-woo
The key interest rate gap between Korea and the U.S. is anticipated to reach an unprecedented level of 2 percentage points, as the Bank of Korea (BOK) held the base rate steady at 3.5 percent Thursday.
The possible 2 percentage point gap increases strain on the Korean economy amid concerns over a potential exodus of foreign capital in pursuit of higher, safer returns. However, market experts believe that the chances of a sudden capital outflow are slim.
On Thursday, the BOK froze its policy rate for the fourth consecutive time, maintaining the 1.75 percentage point gap with the U.S. interest rate. Even though this is already the largest gap the country has ever seen, the difference is expected to widen further, with the Federal Reserve likely to raise its rate by an additional 0.25 percentage point at its July 25 meeting.
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"Even if the U.S. raises interest rates once more, the possibilities of abrupt capital outflow are low," said Kim Dong-heon, an economics professor at Korea University.
"The exchange rate would skyrocket if Korea's economy was as bad as it was during the Asian financial crisis. But I believe this is not the case," Kim said. "The current exchange rate of 1,300 won per dollar is not at a worrying level. Given that the government and the BOK are managing macroeconomic conditions with utmost attention, a 2 percentage point gap would not severely hit the economy."
Historically, the U.S.' interest rate was higher than Korea's between January 2000 and March 2001 (1.5 percentage points), August 2005 and September 2007 (1 percentage point), March 2018 and February 2020 (1 percentage point), and July 2022 and now (1.75 percentage points).
However, according to a recent report from the Korea Capital Market Institute (KCMI), foreign investments did not show a significant decline during those periods.
"Rather, investments in domestic bonds significantly increased (during these periods), showing a net inflow into domestic securities investment funds by foreign investors," said Lee Seung-ho, a senior research fellow of KCMI and the author of the report.
The recent flow of funds has remained stable as well. Foreign investments continued to see a net inflow from February through June. The inflow of funds increased in both May and June when the interest gap already reached 1.75 percentage points.
But other experts cautioned against complacency.
Last month's net inflow plummeted to about a quarter of the level in May. Moreover, there was a net outflow of foreign investments from the domestic stock market in June for the first time since March.
If the Federal Reserve raises policy rates again in September following a July increase, the BOK should seriously consider further rate hikes, experts say.
"Even if it's not an immediate concern, the gap is already unprecedentedly wide. There will be a need to narrow it down when the opportunity arises in the future," said Sung Tae-yoon, an economics professor at Yonsei University.
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