Credit ratings matter
The author is an editorial writer of the JoongAng Ilbo.
The Moon Jae-in administration’s emergency relief grants have been doled out. The money should be a godsend to those without jobs and regular incomes. They can at least buy food and necessities from stores. But that aid could end up a drop in the bucket considering the uncertainties of the Covid-19 threat.
South Korea is being closely watched by investors across the world. They are not sure if the country is safe to keep their money in, given the government spending spree, which includes three supplementary budgets over the last three months on top of a record 2020 budget.
In a recent interview with the JoongAng Ilbo, Rhee Chang-yong, Asia-Pacific director for the IMF, warned that the country’s future will not be bright if people vote for politicians who promise cash handouts to solve economic troubles. Unlike the United States and the European Union, who can easily print money since their currencies are internationally traded, too much fiscal spending in South Korea could cause a sharp depreciation in the local currency.
If policymakers pay heed to the warning about the impact on the foreign exchange rate from excess fiscal spending, they cannot so easily resort to budgetary spending. The government has been aggressive in fiscal expansion. President Moon questioned the meaning of keeping to the 40 percent threshold on the ratio of the national debt to GDP. He even ordered the Ministry of Economy and Finance to push beyond the 40 percent threshold in planning budgetary spending. In fact, there are no strong grounds on why South Korea should keep its debt ratio below 40 percent of GDP. But there are overseas benchmarks. The EU set the national debt-to-GDP ratio at 60 percent — and fiscal deficit at 3 percent of GDP — for eurozone membership.
If national debt increases, so do fiscal deficits. Debt levels should be watched through their ratio against the GDP. Previous administrations thought that if Europe needs to set its level at 60 percent, South Korea should keep it at around 40 percent, given its geopolitical risk from North Korea.
The Moon administration does not agree. It cannot understand why South Korea must contain the level at 40 percent when other developed economies like the United States has their level hovering at 100 percent. The government argues aggressive expansion is inevitable to cope with an unprecedented virus disaster. They even borrow the left-leaning concept Modern Monetary Theory being floated in advanced economies to justify deficit budgeting and debt financing with the simple argument that there is no problem with printing their own money in their own country no matter how much they print.
But South Korea is not the United States, Japan or the eurozone. Foreign investors put their greenbacks into Korean securities on the condition that the Korean won’s exchange rate stays stable. If our national debt stretches, so do our fiscal deficits. If the economy slows and companies cannot earn profits, government finances could deteriorate. International credit agencies could downgrade government and corporate debt ratings. If that happens, foreign investors would flee as they did during the Asian financial crisis.
If the foreign exchange rate turns volatile, the hard-earned foreign exchange reserves of $400 billion might not be enough. Heedless debt increases can be dangerous. International organizations believe Korea still has room to spend more — but only if it spends productively. They also stress the need for deregulation in Korea.
Bloomberg Intelligence first raised the alarm about the surge in Korea’s fiscal spending and predicted that its sovereign debt-to-GDP ratio will soar to the 50 percent level even if its economy grows 2.1 percent next year. Korea’s fiscal integrity is being challenged, and runaway debt hurts the next generation. Before that happens, our sovereign rating could be lowered. Former U.S. President Bill Clinton’s campaign slogan in 1992 was, “It’s the economy, stupid!” Let’s change that to: “It’s the sovereign debt rating, stupid!”
JoongAng Ilbo, May 20, Page 30