BOK under pressure to cut key rate further

Bank of Korea Governor Lee Ju-yeol enters an elevator at the bank in central Seoul, Monday. Lee was scheduled to return to Korea Tuesday but came back a day earlier, Monday, to discuss measures for containing any domestic economic fallout from the U.K.'s choice to leave the European Union. / Yonhap

Gov't to unveil extra budget plan today

By Nam Hyun-woo

Bank of Korea (BOK) Governor Lee Ju-yeol is facing growing pressure to cut the central bank's key rate further to help contain the fallout of Britain's exit from the European Union, analysts said Monday.

The BOK unexpectedly cut the benchmark rate to a record low 1.25 percent earlier this month to cope with increased downward risks that have come amid plunging exports and the ongoing massive corporate restructuring.

Analysts say the Brexit decision will force the U.S. Federal Reserve to delay a planned rate hike, and market interest rates already reflect expectations of another rate cut from the central bank.

"On Monday, the interest rate of the three-year Korea Treasury Bond plunged below 1.25 percent, which is lower than the policy rate," said Lim Dong-min, an economist at Kyobo Securities. "This signals that the market is already expecting an extra rate cut."

He said increased downside risks for the Korean economy and prospects of weaker exports will add pressure to the BOK to act. "The slowdown in exports will likely continue, while domestic consumption will likely remain stagnant and the Brexit will anyhow affect the country's economy," Lim said. "Given that this will force the central bank to increase liquidity in the market, it will likely conduct a serious review over lowering the key rate."

Foreign analysts echoed Lim's view. Morgan Stanley said in a report: "We think the BOK could engage in further policy rate cuts to mitigate downside risks."

Bank of America Merrill Lynch also said that the possibility of a rate cut has been increased as the Fed may delay a rate hike until next year.

However, Lee said Monday that the financial entities should be more prudent.

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"The Korean economy, which is vulnerable to external factors, has no option to avoid negative effects from Brexit, but I believe financial entities do not have to respond too sensitively to short-term changes."

Extra budget in the pipeline

The fallout of Brexit also props up the necessity for the government to set up a larger supplementary budget.

The financial authorities have been wavering over implementing aggressive fiscal policies including a supplementary budget, but last week's Brexit decision led the government to lean on expanding its budget, while a number of research institutes are backing up the move with their timid growth outlook for this year.

The government will announce its economic policy guidelines for the second half of the year today. The announcement will include whether it will decide on a supplementary budget and how large it will be.

Though the popular opinion is that Korea's economy is "moderately exposed" to Brexit fallout — given its 1.4 percent reliance on U.K.-bound exports — analysts say increased uncertainties and downside risks will force the government to place a budget increase in the pipeline.

The government recently lowered its economic growth outlook this year from 3.1 percent to 2.8 percent. However, research institutions still doubt whether the country can meet the lowered target and voice the necessity of a super-sized supplementary budget.

Hyundai Research Institute said Sunday that there is "an urgent need for a supplementary budget" given that external factors including Brexit are affecting the Korean economy, which already is contending with massive corporate restructuring. It stressed the government needs to spend up to 26.6 trillion won.

Along with Hyundai Research Institute, private researchers have already released their growth outlooks that are lower than the government's 2.8 percent, stressing the necessity of the supplementary budget. Foreign researchers also echoed the domestic view, with Citigroup expecting 15 trillion won to 20 trillion won in extra spending to offset the fallout of Brexit, and thus improving Korea's growth outlook by 0.1 percentage points in the second half and 0.2 percentage points next year.

Amid increasing downside risks and ongoing corporate restructuring in the challenged shipbuilding and shipping industries, the government has been considering expanding its budget, but is making prudent gestures. One of the reasons is relevant laws state that such a budget can only be established when the economy is affected by a major crisis, including war, natural disaster or massive unemployment.

The current administration has come up with a supplementary budget twice, when the ferry Sewol sank resulting in the deaths of 304 people in 2014, and during the Middle East Respiratory Syndrome outbreak here last year.

However, as a report from Statistics Korea on June 15 showed an increasing unemployment rate, pundits say "the conditions are set" for another bout of spending.