All eyes on low policy rate change

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All eyes on low policy rate change

The biggest question the market has today is whether the Korean central bank will lower the already low 1.5 percent policy rate, as China’s unsteady market is likely to have a negative impact on Korea’s financial stability and economic growth is expected to fall.

The first sign of trouble came last week when the Chinese central bank in an unexpected move depreciated the renminbi more than 4 percent for three consecutive days. Markets gradually settled as the People’s Bank of China (PBOC) on Wednesday set the exchange rate at 6.3963 against the dollar from Tuesday’s 6.3966.

However, despite the move - which is considered an attempt at a soft landing for the country’s struggling economy - both the Chinese stock market and the Korean stock market have responded negatively.

The Seoul main bourse, which had been sliding for eight trading days since Aug. 6, bounced back on Thursday last week. During the same period, the Kospi lost nearly 3.7 percent.

The Chinese central bank has stressed there will be no additional devaluation of its currency.

But market experts are projecting there could be an additional drop in the renminbi’s value. In a recent survey by Bloomberg, 30 economists said the yuan could further devalue roughly 1.5 percent to 6.5.

Suh Dae-il, an analyst at KDB Daewoo Securities, said even if the yuan volatility is reduced in the short run, the impact it has in emerging markets, including Korea, will likely continue.

“The devaluation of the yuan has once again reminded of the two major risks that the majority of emerging markets have been under - stagnant economy and exodus of foreign investments,” Suh said. “Additionally, there is still the risk that follows the interest rate hike by the U.S. Fed next month.”

Kim Kyung-hwan, an analyst at Hana Daetoo Securities, said that in the second half, both the Chinese stock market and even the real economy will likely struggle despite various methods, including monetary, fiscal and real estate.

“The market is already under accumulated stress added to the yuan devaluation and investment exodus,” said Kim of Hana Daetoo Securities.

According to the International Monetary Fund’s study, when the Chinese economy sees a one percentage point drop in its growth, the other Asian markets will see a 0.3 percentage point drop in its own economy. The countries most likely affected by the deceleration of the Chinese economy will be Korea, Malaysian, Taiwan and Thailand, while Japan and India will be the least affected.

Pressure for another rate cut, that is already at the historic low of 1.5 percent, is building.

In fact, Minister of Finance Choi Kyung-hwan said on Tuesday that it was unlikely the nation’s benchmark borrowing rate will be raised.

“Even if the U.S. raises its interest rate, there is no need for the Bank of Korea to immediately raise the key interest rate,” Choi said. “Other countries do not link their monetary policy with those of the U.S.”

The comment by the finance minister is unusual considering the nation’s leading economic policy maker has in the past refrained from making comments regarding the policy rates, as it is a sensitive issue to BOK’s independence.

Choi’s comment comes as he is planning to meet the central bank governor later this month.

The last time the two met, after Choi was appointed as the Finance Minister in July, the central bank lowered the key interest rate the following month. When the two attended the G20 Finance Minister and center bank governors meeting in Sydney, Australia, in October, the BOK made an additional rate cut.

But there is also the possibility the Korean central bank could continue the key rate until the end of this year. At a press conference held on Thursday, BOK Governor Lee Ju-yeol said he has no plans to control the exchange rate with the policy rate.

“[The devaluation of the Chinese yuan] seems to have effects on [Korea’s] export competitiveness and the exodus of foreign investment,” Lee said at the press conference. “But the influence is very complex. We will make our decision based on the progress of the Chinese yuan exchange and the influence it will have on the Korean export and capital flow.”

The comment was interpreted as a hawkish stance to hold the key rate for the time being.

“It seems that the central bank governor is focused more on stabilizing the financial market rather than on the downward risks on the economy,” said Yoon Seo-sam, an analyst at KDB Daewoo Securities.

“The most important question will be whether the economy will likely achieve the growth path that the BOK has presented until the fourth quarter.”

Yoon, however, noted that the devaluation of the Chinese yuan will not have a positive effect on the Korean economy as some seem to believe.

“The argument that the enhanced Chinese export competitiveness resulting from the yuan devaluation will contribute to Korea’s own economic growth only works under an environment where China is enjoying strong growth,” the analyst said. “But the impact on the Korean economy will not be as positive as it was in the past.”

He added that at a time when the global trade by volume has been shrinking, a simple depreciation of a currency will not have much impact. The biggest problem is that there is a lack of demand due to uncertainty about the economic future, not only in Korea but the overall global market.

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