In line with market expectations, the Bank of Korea on Wednesday cut its policy rate by a quarter percentage point to 1.25 percent, which matches the lowest level seen from June 2016 to November 2017.
Growing downside risks and low inflation led the central bank to lower the base rate for the second time in three months.
The growth momentum of Korea’s economy is expected to further weaken down the road amid slumping exports and sluggish investments. Outbound shipments from Asia’s fourth-largest economy recorded an on-year decline for 10 consecutive months in September due to a trade spat between the US and China and a fall in semiconductor prices. In tandem with sluggish exports, facility investments in the country shrank 11.7 percent in the first eight months of the year compared with a year earlier.
The International Monetary Fund on Tuesday lowered its growth estimate for Korea this year to 2 percent from its previous forecast of 2.6 percent in April.
In its latest projection in July, BOK forecast the country’s gross domestic product would expand 2.2 percent this year, down from the 2.5 percent projected in April. The central bank is expected to further downgrade its growth outlook for 2019 next month. In a press briefing following the announcement of the latest rate cut, BOK Gov. Lee Ju-yeol said the country’s growth rate could fall short of the July estimate.
Earlier this month, global rating agency Standard & Poor’s joined foreign and domestic institutions that have lowered Korea’s growth outlook for this year to below 2 percent.
Increasing concerns about Korea’s economy is the possibility of deflation with the loss of growth momentum. Expectations of low inflation or deflation could lead to a reduction in consumption, further weighing on the economy troubled with slumping exports and shrinking investments.
Consumer prices rose at a record low of 0.5 percent on-year in the first eight months of the year. In September, consumer prices fell 0.4 percent from a year earlier, marking the first on-year negative increase in inflation since the state statistics office began compiling related data in 1965.
The central bank head noted the low inflation has stemmed largely from a base effect caused by a surge in prices of agricultural products last year. He said the price increase is expected to stay below 1 percent for the remainder of the year before breaching the 1 percent mark early next year. Still, the BOK’s annual target of 2 percent will remain out of reach.
As the economy is being drawn into a low growth rut coupled with low inflation, the BOK may go for an additional rate cut by a quarter percentage point early next year. Lee hinted at the possibility Wednesday by saying he believes the central bank “still reserves policy room to take action when necessary.”
The rate cut, however, raises concerns about a sharp rise in the country’s household debt, which reached a record high of 1,556.1 trillion won ($1.31 trillion) as of end-June. An increasing supply of money would go into the real estate sector rather than boost investment and consumption, as home prices, particularly in Seoul, are soaring due to a string of ill-conceived measures taken by the government over the past year.
President Moon Jae-in and his economic aides have insisted the economy is doing fairly well. But it is hard to give credence to their argument when the key policy rate has been cut to a record-low level to help bolster the economy.
The government should not attempt to gloss over real conditions by shedding light on some selected indicators that appear to have improved as a result of expanded fiscal spending. Moon’s economic team was buoyed by data released Wednesday that showed the country’s employment rate hit a 23-year high in September with more jobs added than in any month over the past five years. But most of the added jobs were temporary ones created with government funding and taken by elderly people. The number of full-time jobs in the manufacturing sector recorded an on-year decrease for 18 consecutive months in September, with the number of employees in their 30s and 40s also shrinking for the 24th straight month.
There are limits to expanding government spending without damaging fiscal soundness, as tax revenue is set to decline amid a prolonged economic slump.
With a mix of monetary easing and fiscal expansion not being an effective and sustainable tool for reviving the economy, the government should implement harder measures -- sweeping deregulation and labor reforms as well as ditching dysfunctional policies.