Institute warns of hike’s impact

With the U.S. Federal Reserve all but guaranteed to hike interest rates today, a local think tank warned about the potential loss of 15 trillion won ($13.4 billion) in foreign investment in the wake of the hawkish U.S. monetary policy.

The Korea Economic Research Institute said on Wednesday that the widely-expected quarter-point increase will reduce foreign equity investments in Korea by 8 trillion won and foreign direct investment by 7 trillion won.

When the Fed lifts the key federal fund rate by 0.25 percentage points to 2-2.25 percent, the rate gap between the two countries will widen to 0.75 percentage points.

“The widening rate gap between Korea and the U.S. will likely increase the pressure for foreign capital flight, at a time when emerging markets’ volatility is intensifying and the domestic economy is experiencing a gradual downturn,” said Lee Seung-seok, a researcher at the institute.

The expected capital reduction also puts Korea’s central bank in a bind, as the latest indicators of slowing economic growth stood in the way of the Bank of Korea (BOK) moving to gradually unwind its expansionary monetary policy. The BOK started the normalization of interest rates last November by pushing up the benchmark rates from a record-low 1.25 percent to 1.5 percent for the first time in six and a half years.

The central bank has since kept the rate unchanged, as it is worried about weakening economic indicators for the job market, consumer sentiment and household income.

BOK Gov. Lee Ju-yeol has said interest rate difference between the two countries is not the sole factor that affects foreign investment, playing down the possibility of large capital exodus.

“When we look at some emerging countries that experience capital exodus, their benchmark interest rates are higher [than other countries],” Lee said in May after a rate-setting meeting. “The rate gap could be one factor, but a country’s economic fundamentals are more important.”

Still, more members at the monetary policy committee appear to be tilting towards a rate hike, based on the meeting’s minutes.

Lee Il-houng, a board member, voted to raise the key interest rate in the last two meetings. In the August meeting, two more members brought up the need to raise the rate in the future, according to the minutes.

The BOK, however, would find it tricky to go straight for a further rise in October or November, as the domestic economy faces headwinds.

The country is seeing record-low numbers of new jobs, tepid business and consumer sentiment and lower-than-expected inflation.

The BOK held an emergency meeting to assess the impact of the U.S. rate hike on Wednesday.

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