Korea faces interest-rate dilemma

The age of ultra-low interest rates is ending. The United States has tapered off its massive monetary easing program and is tightening now that the economy is running well. The Korean economy is in a dilemma; confidence here is probably too weak to match the U.S. moves. It inevitably has to join the tightening trend, but economic conditions here are worsening. A widening gap with U.S. rates can stoke foreign capital flight and further harm the domestic market.

The U.S. Federal Reserve on Monday raised the fed funds target to 2-2.25 percent, its eighth hike since December 2015. During the same period, the Korean policy rate has stayed unchanged since a single 25 basis-point hike last November, widening the gap with U.S. rates by 75 basis points. U.S. Fed meeting notes suggest there may be one more hike this year and three more next year.

Money chases higher returns. If the gap in interest rates goes beyond a certain level, foreign capital will pull out of Korean assets. According to the Korea Economic Research Institute, a gap of 25 basis points in U.S. and Korean rates could cause as much as 15 trillion won ($13.5 billion) worth foreign capital to pack up and leave. The higher rates in the United States have already spurred capital flight from vulnerable emerging economies like Argentina, Turkey and Indonesia.

Despite the urgency, the Bank of Korea is up against the wall. It should raise interest rates considering the U.S. move and our overheated housing market. But it must be mindful of the colossal 1,500 trillion won worth of household debt. A heavier interest burden could trigger chain insolvencies of self-employed and heavy debtors. According to the Bank of Korea, loans to self-employed reached 591 trillion won by the end of June, up 42 trillion won from six months ago. An average Korean is 350 million won in debt; 4.18 million Koreans owed three or more creditors 493 trillion won. A one-point hike raises the annual interest burden by 18 percent.

Brent crude oil prices have climbed over $80 per barrel as result of the escalating U.S.-China trade war. The Organization for Economic Cooperation and Development downgraded this year’s growth outlook for Korea from 3 percent to 2.7 percent. When maneuvering room is limited, it is best to stick to the basics. The government’s income-led growth policy has dampened our fragile growth. Only improvements in productivity can help. Authorities must push for radical reforms to vitalize the private sector.

JoongAng Ilbo, Sept. 28, Page 38