Fed’s rate hike leaves S. Korea with hard tasks

The U.S. Federal Reserve (Fed) raised the federal-funds rate by a quarter of a percentage point to between 0.50 percent and 0.75 percent. It matches the increase the Fed applied in December 2015, putting an end to the zero rate policy since the 2008 financial crisis. Fed Chair Janet Yellen said that the decision should be understood as a reflection of the confidence in the economy. This indicates a move to tighten the dollar supply, in light of improving employment rates and consumer sentiment amid growing expectations for economic growth on the election of Donald Trump with business experience.

However, the Bank of Korea kept its base rate unchanged at 1.25 percent on Wednesday, considering weak domestic demand and increased downside risk on economic growth. The decisions by the Fed and the central bank suggest the different realities of the U.S. as a superpower and Korea with a weaker status. When the Fed said that it will raise rates at a very slow pace when announcing the rate hike a year ago, the Korean government was given tasks of a soft-landing for the housing market and household debt as well as restructuring of insolvent companies. However, none of the tasks has been completed. Insolvent companies are still running business, while Hanjin Shipping filed for court protection as the government refused to reschedule its debt. Increased apartment prices have inflated the real estate bubble and household debt has increased to a record 1,300 trillion Korean won (1.1 trillion U.S. dollars). Recently, the Choi Soon-sil gate has also increased political uncertainties.

If facing an unexpected shock in 2017, the Fed could slow the rate hike pace slightly. The Korean financial authorities need to cooperate closely to overcome the crisis. However, the Ministry of Strategy and Finance sticks to conventional supply-side stimulus measures, while the central bank emphasizes financial stability, saying that it should consider many factors, not just growth and prices. There is criticism that the financial authorities are in confrontation even with the imminent crisis.

Despite the Fed’s rate hike, the rate gap between Korea and the U.S. is still large, meaning that it will take some time before seeing the outflow of foreign investments. The Korean government and the central bank should keep calm amid instabilities in the international financial markets. They should establish measures to prevent high-interest loans from progressing into NPLs and enable a soft-landing of the real estate market. It is also important to maintain the constant restructuring system to prevent a sudden rise in insolvency levels. Now, the government has less than half a year to complete its tasks.