Experts Urge Exit Strategy of ‘Low Intensity’

The Bank of Korea and financial authorities are reviewing absorbing market liquidity through measures such as lowering the aggregate credit ceiling or reducing loans to small and medium-sized enterprises.

Though bank governor Lee Seong-tae hinted at raising interest rates Thursday, financial authorities apparently seek market stability with relatively less intensive measures since a rate hike could bring negative consequences, such as a reduction in real household income.

Many experts also agree on a less intense exit strategy aimed at gradually absorbing liquidity to minimize the impact on the market.

○ Gradual exit strategies to be reviewed next month

The Bank of Korea is likely to first review measures to lower aggregate credit ceiling as early as next month to take in market liquidity. The system allows the central bank to provide smaller businesses with capital at below market interest rates.

The amount ceiling of such capital rose from 6.5 trillion to 9 trillion won (5.3 billion to 7.3 billion U.S. dollars) in October last year. It again expanded to 10 trillion won (8.1 billion dollars) in March this year.

In addition, the central bank will repay this year most of the 16.3 billion dollars provided by the U.S. Federal Reserve in January as part of a bilateral currency swap. Korea has repaid 11.75 billion dollars of the amount.

The bank said further dollar supply is unnecessary since the foreign exchange market has improved.

The bank is also seeking to reduce liquidity by raising reserve requirements for banks that mandates them to deposit a certain portion of their customers’ savings in the central bank. Though the bank has not revised the reserve requirements since the outbreak of the global economic crisis, the proposed plan is different from other policies designed to reduce liquidity supply.

Nevertheless, many financial experts say the plan is likely to go ahead before an interest rate rise if the rebound in housing loans continues.

Another measure under review is to reduce the scope of securities eligible for public market manipulation that controls market liquidity by adjusting the amount of bonds issued. Though treasury, government guaranteed, currency stabilization bond, bank and Korea Housing Finance Corp. bonds are leveraged for public market manipulation, the last two will be excluded beginning in November.

Financial authorities will confirm next month whether to extend the deadline for guarantee expansion and maturity extension measures to alleviate the burden of cash-strapped smaller business initiated in February from the end of this year to next year.

A financial official said, “We will decide whether guarantee expansion measures will be maintained or terminated at the end of October by reviewing economic conditions that month. Though the deadline for bank loan payment guarantee scheduled for the end of June has been extended to year’s end, an additional extension is unlikely.”

○ Housing price stability

Since the discussion on an exit strategy has mostly been rekindled by a rise in real estate prices, experts say the intensity and timing of the measures will be determined by changes in housing prices.

The debt-to-income regulation that limits lending in proportion to income was extended to the entire Seoul metropolitan area Monday. Consequently, the government has expressed fears over the possible transfer of lending demand from banks to insurance companies or thrifts, though the rise of housing loans by banks has been dented.

Another source of worry is that housing inflation usually witnessed in three Seoul districts of the affluent Gangnam area (Gangnam, Seocho and Songpa) have spread to other areas of the city, including Gwanak in the southwest and Nowon in the northeast.

Bae Sang-geun, head of the economy headquarters of the Federation of Korean Industries, said, “Before authorities go ahead with raising the interest rate, which is considered an extremely strong measure, they should first revise policies for individual areas such as extending debt maturity deadline for smaller businesses and reducing payment guarantees.”

legman@donga.com