By John Burton
Is Korea heading for an economic and financial crisis? There are some disturbing signs. The KOSPI stock index has been among the worst-performing in the world this year. Inflation was up 5.4 percent in May, the highest since 2008, and could reach 6 percent in the next few months due to soaring energy prices. The value of the won against the U.S. dollar has fallen to its lowest level since September 2009.
The plunging value of the won means that the cost of imports, including dollar-denominated oil and natural gas, is becoming more expensive, which feeds inflation. One reason why the value of the won has fallen so dramatically is that foreign investors are exiting the stock market, selling their won-denominated assets for dollars. The process can feed on itself since Korean stocks are worth less to foreign investors as the won weakens further.
The Bank of Korea has been trying to halt the slide in the won's value by buying Korean currency on international exchanges. But the most effective way to support the won would be to raise interest rates, which would attract foreign money back to Korean financial markets.
However, raising the benchmark interest rate creates its own problems since it raises the cost of local borrowing, when Korea already has one of the highest household debt levels in the world, caused largely by escalating real estate prices. If interest rates become too high, it could pop the property bubble and result in a financial crisis for many Koreans who pay variable mortgage loans.
This is the dilemma that President Yoon Suk-yeol faces and one that could destroy his presidency quickly if he is not careful. After all, one of the reasons he was elected was public anger over climbing property prices, particularly in Seoul where he scored a victory in the March presidential election over Lee Jae-myung.
Moreover, Yoon must operate in a difficult political landscape as he faces tough choices in economic and financial policies. He won the presidency only narrowly and his public support remains weak, while the opposition will control the National Assembly until 2024.
The Bank of Korea so far appears committed to raising interest rates to combat inflation. It has conducted five rate hikes to reach the current benchmark rate of 1.75 percent despite its traditional concerns about the impact of higher interest rates on household debt. More rate hikes are expected this year. Higher interest rates are needed to curb the growth in loans to households that helped fuel the speculation in real estate in recent years.
But rising interest rates also means that people will spend less on products, one reason why the stock market has fallen by around 20 percent this year as companies are expected to report lower profits. While foreign investors and domestic institutions are dumping stocks, retail investors continue to buy ― perhaps in hope of making a killing later on since the stock index is considered undervalued compared to historical trends.
There are also expectations that exports can make up for sluggish domestic demand as the global economy recovers from the COVID pandemic gradually. Total exports rose by 21 percent in May from a year earlier.
The Yoon administration is hoping that pro-business policies, which include deregulation, tax cuts and less government spending, will help get the situation under control.
It blames increased stimulus spending during the pandemic by the previous Moon Jae-in administration for contributing to inflationary pressures. It claims that significant hikes in the minimum wage mandated by the government exacerbated the inflation problem. At the same time, a reduction in maximum working hours led to slower productivity that resulted in a collapse in corporate investments.
It also believes that the Moon administration's efforts to curb real estate speculation through stricter lending criteria backfired since it discouraged the building of more units in such sought-after areas as Seoul's Gangnam-gu. The resulting shortage of apartments drove up prices.
But Yoon may have a tough time pushing through his economic reforms in the opposition-controlled National Assembly. A proposed cut in the corporate tax rate and various deregulation measures must be approved by lawmakers.
Moreover, other significant factors are out of Yoon's control. If the U.S. central bank continues to raise interest rates, it will force Seoul to do the same or else face the risk of having more money leave Korea. An increase in borrowing costs could result in more business insolvencies or discourage companies from making new investments. This would be the opposite of what Yoon hopes to achieve.
The next few months could determine the success or failure of the Yoon administration as it grapples with the country's economic challenges.
John Burton (johnburtonft@yahoo.com), a former Korea correspondent for the Financial Times, is a Washington, D.C.-based journalist and consultant.
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The plunging value of the won means that the cost of imports, including dollar-denominated oil and natural gas, is becoming more expensive, which feeds inflation. One reason why the value of the won has fallen so dramatically is that foreign investors are exiting the stock market, selling their won-denominated assets for dollars. The process can feed on itself since Korean stocks are worth less to foreign investors as the won weakens further.
The Bank of Korea has been trying to halt the slide in the won's value by buying Korean currency on international exchanges. But the most effective way to support the won would be to raise interest rates, which would attract foreign money back to Korean financial markets.
However, raising the benchmark interest rate creates its own problems since it raises the cost of local borrowing, when Korea already has one of the highest household debt levels in the world, caused largely by escalating real estate prices. If interest rates become too high, it could pop the property bubble and result in a financial crisis for many Koreans who pay variable mortgage loans.
This is the dilemma that President Yoon Suk-yeol faces and one that could destroy his presidency quickly if he is not careful. After all, one of the reasons he was elected was public anger over climbing property prices, particularly in Seoul where he scored a victory in the March presidential election over Lee Jae-myung.
Moreover, Yoon must operate in a difficult political landscape as he faces tough choices in economic and financial policies. He won the presidency only narrowly and his public support remains weak, while the opposition will control the National Assembly until 2024.
The Bank of Korea so far appears committed to raising interest rates to combat inflation. It has conducted five rate hikes to reach the current benchmark rate of 1.75 percent despite its traditional concerns about the impact of higher interest rates on household debt. More rate hikes are expected this year. Higher interest rates are needed to curb the growth in loans to households that helped fuel the speculation in real estate in recent years.
But rising interest rates also means that people will spend less on products, one reason why the stock market has fallen by around 20 percent this year as companies are expected to report lower profits. While foreign investors and domestic institutions are dumping stocks, retail investors continue to buy ― perhaps in hope of making a killing later on since the stock index is considered undervalued compared to historical trends.
There are also expectations that exports can make up for sluggish domestic demand as the global economy recovers from the COVID pandemic gradually. Total exports rose by 21 percent in May from a year earlier.
The Yoon administration is hoping that pro-business policies, which include deregulation, tax cuts and less government spending, will help get the situation under control.
It blames increased stimulus spending during the pandemic by the previous Moon Jae-in administration for contributing to inflationary pressures. It claims that significant hikes in the minimum wage mandated by the government exacerbated the inflation problem. At the same time, a reduction in maximum working hours led to slower productivity that resulted in a collapse in corporate investments.
It also believes that the Moon administration's efforts to curb real estate speculation through stricter lending criteria backfired since it discouraged the building of more units in such sought-after areas as Seoul's Gangnam-gu. The resulting shortage of apartments drove up prices.
But Yoon may have a tough time pushing through his economic reforms in the opposition-controlled National Assembly. A proposed cut in the corporate tax rate and various deregulation measures must be approved by lawmakers.
Moreover, other significant factors are out of Yoon's control. If the U.S. central bank continues to raise interest rates, it will force Seoul to do the same or else face the risk of having more money leave Korea. An increase in borrowing costs could result in more business insolvencies or discourage companies from making new investments. This would be the opposite of what Yoon hopes to achieve.
The next few months could determine the success or failure of the Yoon administration as it grapples with the country's economic challenges.
John Burton (johnburtonft@yahoo.com), a former Korea correspondent for the Financial Times, is a Washington, D.C.-based journalist and consultant.
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