Inflation drops to worrying level

Consumer prices rose by 1.5 percent in July, the lowest level in 12 years.

The sharp fall in inflationary pressure will surely help households, but it also brings the risk of Japanese-style deflation.

According to Statistics Korea yesterday, the July growth in consumer prices, the lowest since May 2000, largely stemmed from stabilization in prices of agricultural products and lower international oil prices. Compared to June, the figure slid by 0.2 percentage points.

The country’s inflation rate has been on a gradual decline for the past eight months, from 4.2 percent late last year to 2.2 percent in June. And last month was the first time inflation fell below 2 percent since July 2009.

“Inflationary pressures decreased, not because the central bank lowered the key interest rate, but because the economy is actually going into the recession stage,” said Yim Hee-jung, a researcher at Hyundai Economic Research Institute.

The Ministry of Strategy and Finance said prices have stabilized largely because consumers and businesses refrained from spending amid lingering uncertainties in the economy.

According to economists, when inflation persists at low levels for a long period of time, the economy might lose its vitality, possibly leading to deflation.

Deflation refers to a decrease in the overall price level of goods and services. It occurs when the inflation rate falls below zero percent.

“Deflation is more dreadful than inflation because it triggers a vicious cycle of lower product prices leading to dwindled corporate profits, less investments by companies, lower wages for workers, and finally a contraction in consumption,” explained Jung Young-sik, a researcher at Samsung Economic Research Institute.

Analysts are worrying about a serious downturn like Japan’s “Lost Decade” between 1991 and 2002, triggered by a collapse of bubbles in stocks and real estate and a string of corporate bankruptcies.

The Korean economy has never experienced deflation in previous economic crises because of its dependence on exports. When global economic conditions turn sour, the won weakens, import prices soar and consumer prices rise.

However, since the 2008 global financial crisis, worries about deflation have risen, especially with external uncertainties like the euro zone crisis.

Finance Minister Bahk Jae-wan said in a radio interview Tuesday there is a possibility that economic growth will fall below 3 percent this year, fueling deflation concerns. Earlier, when the Bank of Korea lowered the benchmark interest rate and its growth forecast to 3 percent, forecasts of “L-shape” growth, or prolonged low growth, abounded.

“Inflation below 2 percent is beyond the central bank’s target, which is not a normal sign,” said Lee Jae-joon, a researcher at the Korea Development Institute. “It can be interpreted as the central bank needing to take additional monetary measures.”

Despite falls in the prices of daily necessities in recent months, consumers are not spending freely because of concurrent drops in prices of their assets, including mortgage-backed real estate.

Most Korean households’ purchasing power is tied to real estate because people take out mortgages in order to live on either two-year jeonse contracts or to buy houses. But the real estate market is dead and no government efforts to revive it have worked.

Meanwhile, the country’s total household debts are about to hit 1,000 trillion won ($887 billion), according to the central bank. About 77 percent of the debtors barely manage to pay interest on their loans.

Deflation could further depreciate housing prices.

By Song Su-hyun [ssh@joongang.co.kr]