BOK in bind as U.S. Fed raises interest rates

The rise in U.S. interest rates, if gradual, is unlikely to trigger an exodus of capital but it could place further pressure on people with a lot of debt, the head of the country’s central bank said in a briefing of the National Assembly today.

“If the Fed gradually raises its benchmark rate, it would not put significant pressure on capital outflow,” Governor Lee Ju-yeol of the Bank of Korea said, noting that Korea’s fiscal soundness is good, with a healthy current account surplus, sufficient foreign reserves and good credit ratings.

Korea’s main stock exchange enjoyed a huge capital inflow thanks to foreign investors even after the U.S. Fed raised its benchmark short-term interest rate in mid-March by 0.25 percentage points to a range of 0.75 percent to 1 percent.

But borrowers might feel the pinch of the Fed hikes, since lending rates here tend to rise in line with the U.S. benchmark fund rate.

The Bank of Korea said that a 1 percent increase in the lending rate will translate into 9 trillion won ($8 billion) additional interest owed on a yearly basis by Korean debtors, with its projection that the Federal Reserve will raise its rate three times this year.

Household debt in Korea reached a record high last year, amounting to 1,344 trillion won by the end of the fourth quarter, nearly a 4 percent rise compared to the third quarter, or about a 12 percent year-on-year increase.

Based on figures from January and February, credit issued by local commercial banks has shown signs of stabilization, rising 3 trillion won during the period, following the government’s efforts to tighten lending standards.

Although the debt level is astronomical, Governor Lee said that two thirds of the household debt is held by borrowers the Bank of Korea consider good credit risks.

But the Bank of Korea is clearly in a bind.

As pressure from abroad to raise interest rates continues to grow, the domestic situation, with declining economic growth and rising household debt, limits the bank’s desire to raise its key rate.

The market consensus is that the Bank of Korea will likely hold its key interest rate at the 1.25 percent level until next month.

A member of the monetary policy committee at the central bank said that Korea’s rate decision is not tied to U.S. moves.

“Korea’s monetary policy should be carried out based on Korea’s economic prospects and inflation trends,” said Cho Dong-chul, one of the seven members of the committee on Wednesday. “If Korea’s macro economic conditions unfold in a different manner with the United States, our monetary policy will also manifest itself in a different way.”

BY PARK EUN-JEE [park.eunjee@joongang.co.kr]