Higher rates add to extra budget conundrum

The key interest rate in Korea has been increased steadily since last August as inflation rises. The Bank of Korea's monetary policy board on Thursday unanimously voted to raise the base rate by 0.25 percentage..

The key interest rate in Korea has been increased steadily since last August as inflation rises.

The Bank of Korea’s monetary policy board on Thursday unanimously voted to raise the base rate by 0.25 percentage points from 1.5 percent to 1.75 percent in a back-to-back hike. The last time Korea’s rate was raised for two consecutive months was in July-August of 2007.

The hike was widely expected due to high inflationary. The consumer price index gained 4.8 percent year-on-year in April, the steepest rise in 13 years and six months.

The bank on the same day revised economic forecasts for the year, yanking up the estimate for annual inflation to 4.5 percent from 3.1 percent in February while lowering the growth outlook to 2.7 percent from 3.0 percent.

Gov. Rhee Chang-yong upon chairing his first rate-setting meeting said monetary policy will focus on containing consumer prices. He has found reining in inflation was more urgent than stimulating the slowing economy.

When asked if he agreed with market anticipation of the key rate going to 2.25 to 2.50 percent by the end of the year, Rhee found such expectations to be “reasonable.”

The ultra-loose policy to aid the economy during Covid-19 pandemic has to be normalized in Korea as well as elsewhere in the world. Tightening can be harsh on the economic participants. As Rhee pointed out, a 25 basis point rise in the base rate could bump up debt financing cost by more than 3 trillion won ($2.4 billion) for households and 2.7 trillion won for companies. All market participants must control their risk. Authorities must take action to ease the hardship, while financial institutions must pay greater attention on asset management.

The U.S. is raising its rates by faster pace due to a stronger economy. The Federal Reserve is expected to take similar big steps in June after a 50-basis-point hike earlier this month.

The bigger hike could place U.S. rates just 25 basis points lower than Korea’s. South Korean markets won’t likely be immediately rocked by fast capital flight and a plunging local currency rate against the dollar if U.S. rates go higher. But the wind in the international financial market could change in our disfavor at any time. Only full readiness can defend a small economy like Korea’s.

If expectations for higher inflation do not come down, the vicious cycle of an upward spiral in wages and inflation will continue.

Politicians are adding fuel to inflation by proposing to stretch an already record-sized supplementary budget. They must come to their senses.