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Structural reform must support for BOK’s 1% range base rate

Structural reform must support for BOK’s 1% range base rate

Posted March. 13, 2015 07:14,   


The Bank of Korea slashed the base rate from 2.00 percent per year to 1.75 percent by 0.25 percentage point at its Monetary Policy Committee meeting on Thursday. Bank of Korea Governor Lee Ju-yeol explained, “As growth is expected to fall below forecasts and inflation is also expected to fall, there is a need to further boost economic recovery momentum.”

The world is in a "currency war," as evidenced by the U.S. and Japan, which have already been engaged in the super low interest rate policy, and China, India and Europe that recently started key rate cut or quantitative easing policies. The Bank of Korea plans to announce a revised this year’s growth rate forecast, downgraded from its January forecast of 3.4 percent. Even the growth rate announced in January was actually the rate lowered from the previous year’s forecast. The central bank, which had been under criticism for lack of "communication" with the market, swiftly reacted this time as if it were pushed by deflation concerns and influence by the politics.

Base rate cut may enhance Korea’s export competitiveness by slowing down the appreciation of the won in the midst of the weak Japanese yen causing negative impact to Korea’s export. However, there are concerns. Key rate slash may fuel the demand for loans, pushing up the household debt, which was around 1,089 trillion won (approx. 972.4 billion U.S. dollars) at the end of last year. The houses that are out in the market for lease on a deposit basis may disappear. Burden of households and businesses for principal and interest of a loan may decrease, but people who live off the interest incurred on their capital may tight their belts. Some point out that the base rate reduction would bring less-than-expected result due to "liquidity trap," which lowering interest rate and releasing money do not lead to consumption and investment, just like in Japan during the so called "lost decade."

Whether it is the interest rate cut or freezing, light and shadow always go hand in hand. The Korean government and the Bank of Korea must maximize the benefit of 1 percent range base rate, "the path that Korea has never traveled before," and minimize the expected side effects. As the central bank pulled out all possible cards that it held in its hand, now the ball is passed to the government and the political sector. Whether it is a service or manufacturing industry, unless the government boldly gets rid of regulations and carries out structural reform for economic recovery, the effect of key rate cut would be very limited.

After the central bank`s announcement of key rate cut, Finance Minister Choi Kyung-hwan said, “The government will pursue structural reform with extraordinary commitment and must bring out tangible results in March or April.” The government has a responsibility to maximize the policy synergy effect, not to make Choi’s pledge as empty words. Politicians should no longer drag down a bill, if it can help to increase income of the public, create jobs and grow the wealth of the nation.