July 29, 2022 13:22
The U.S. Federal Reserve hiked its key interest rate by a drastic 0.75 percentage point for the second month in a row to 2.5 percent. This is now higher than Korea's base interest rate of 2.25 percent and inverts the usual relationship, which could prompt foreign investors to sell Korean stocks and bonds and move their money to the U.S., where they can earn better interest on it. In the process, there is a risk of financial instability, such as a sharp weakening of the Korean won, a drastic decline in stock prices, and a surge in market interest rates. These signs are already becoming apparent. Foreign investors have sold W17 trillion worth of Korean stocks so far this year and also sold off Korean bonds since June.
The Fed has vowed to raise interest rates aggressively in order to tame soaring inflation that has risen to the nine percent range. It is expected to raise the key rate to 3.5-4 percent within this year. In order to prevent an exodus of foreign investors and defend the won, the Bank of Korea must continue to raise the key rate as well. Consumer prices have grown more than six percent, and expected inflation has risen to a record 4.7 percent.
The problem is that Koreans have borrowed so much due to ultra-low interest rates that a sudden hike could have a devastating impact. Household debt now amounts to a staggering W1.8 quadrillion and corporate debt to W2.3 quadrillion (US$1=W1,296).
If the interest rate hikes continue, the debt-servicing burden will rise exponentially. People in their 20s and 30s who took out loans to buy homes and small business owners who borrowed money to stay open during the pandemic will be hit hard. A string of corporate bankruptcies is a very real possibility.
There is no magic bullet. Everyone has to strap up and play their parts. The government and BOK must cooperate closely and come up with measures to minimize the impact on the public. Businesses must boost productivity to cushion the impact of high interest rates and soaring consumer prices, while households need to cut back on spending. To help Koreans through this painful period, the National Assembly must ease regulations to allow businesses to invest freely. This is no time for politicians to bicker and procrastinate.
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