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Raise the Interest Rate?

Posted June. 20, 2005 03:01,   


Interest Rate Surges Due to Admission of Low Rate Disadvantage-

Bank of Korea (BOK) Governor Park Seung said in his briefing to the National Assembly on June 13, “It’s hard to deny that part of the reason for surging property prices is the prolonged trend of low interest rates,” and added, “We are debating whether to raise the interest rate in response to the overheated real estate market.”

One June 15, Vice Premier and Finance and Economy Minister Han Duck-soo stated in the report to the National Assembly, “I agree that the low interest rate policy is partly generating a real estate bubble.”

The market responded immediately.

It did so as the “hope” that the monetary authority will further lower the overnight call rate (the interest rate applied to immediately available funds between financial institutions) to boost the economy turned into “concerns.” The participants of the bond market sold off their bonds.

They intend to sell the bonds before the price drops because the long- and short-term rates will go up (bond price falls) as the call rate rises.

The benchmark three-year treasury bond rate rose dramatically by over 0.1 percentage points on June 13 and 15, respectively from an annual rate of 3.65 percent to 3.86 percent on June 17.

“Raise the Interest Rate to Reign in the Real Estate Price”-

The argument recently gaining weight is that the measure to fundamentally deal with real estate prices is to raise the interest rate. The rationale behind this is that once the interest rate goes up, people who bought houses on loans will have to put the buildings up for sale with an increased interest servicing burden, which will eventually reduce the bubble.

The senior researcher with Samsung Economic Research Institute, Park Jae-ryong, noted, “Unless there is at least a 0.5 percentage point hike in interest rates, a vicious cycle will repeat itself. That is, a low interest rate causes real estate speculation, which triggers regulation against speculation, which in turn brings a slump in the service industry, which finally causes a downward adjustment of interest rates (to boost domestic consumption).”

Economics professor at Sogang University Kim Gwang-doo also said, “The tax audit and administrative regulation by the government may temporarily halt surging property prices, but it cannot control the skyrocketing housing price fueled by low interest rates.”

Kim criticized the government, saying that even though it put real estate price stabilization to the fore as its top priority with its inauguration in February of 2003, it cut the interest rate four times in May and July the same year, in August and November the following year, and led investors’ money to confidently flow into the “sea of real estate.”

“Side Effects Too Significant”-

There is an equal share of counter-arguments based on fear of crippling the economy.

Yoo Byung-gyu, the economics department chief at the Hyundai Research Institute (HRI), said, “We have to be cautious in raising the interest rate because the rise in real estate prices is not pervasive, and domestic demand is not picking up yet.”

He proposed, “We have to divert money in the real estate market to the financial market by developing high-yield financial products with income tax breaks and find ways to promote private equity funds and the stock market.”

A researcher at LG Economic Research Institute, Kim Seong-shik, diagnosed the situation, saying, “Japan experienced a real estate bubble in the past during an economic boom, but the one in Korea is more malicious as it is taking place amid vulnerable macroeconomic conditions.”

However, he contended, “It does not make sense to compare the situation to that in Japan because the loan-to-value ratio (LTV) of mortgage loans is not as high as its Japanese counterpart.”

“It’s hardly likely that financial companies will go insolvent over the bubble bursting, and raising the interest rate abruptly is not appropriate,” said researcher Kim.

Draw the “Knife” of Lifting Interest Rates?-

The BOK will not find it easy to raise the overnight call rate, either.

Governor Park said, “It’s not yet time for the BOK to intervene directly as consumer sentiment is running severely low and is coupled with real estate problems.”

A BOK official explained, “It’s the same as us not being able to use the knife used to slaughter cows (raising interest rates) to kill chickens (real estate prices).”

This implies raising interest rates could very likely deal a larger blow to real consumers instead of speculators and further dampen domestic consumption.

Professor of real estate at Konkuk University Ko Seong-soo advised, “If we do not immediately lift the interest rate, at least there is a need to make investors turn their eyes to alternative investment tools instead of real estate by signaling the possibility of a hike.”