[INTERVIEW] IMF downplays concerns over inflation in Korea

Country has ample FX holdings, strong external position

By Kim Yoo-chul

The International Monetary Fund (IMF) said it is seeing signs that Korea's inflation growth is decelerating and expects overall consumer prices in Asia's fourth-largest economy to decline throughout next year.

Speaking to The Korea Times, Krishna Srinivasan, director of the IMF's Asia and Pacific department, said the Bank of Korea (BOK) has been nimble and ahead of the curve in its rate policy settings. "The IMF thinks this is helping to combat inflation, despite the substantial external shocks Korea has experienced, and has reduced the risk that a sharper tightening would be needed later," Srinivasan said in an interview.

Citing monthly increases in headline inflation, the recently eased core consumer price index (CPI) and signs of a muted fluctuation in global commodity prices, the IMF official said, "Indeed, while inflation is currently above the two-percent target, we see signs that it is decelerating. We expect overall inflation to peak this year and gradually decline toward the two-percent target."

Headline inflation, better known as CPI, includes more volatile food and energy price data, while the core CPI excludes it.

Regarding questions over its expectations of the country's inflation level in the coming months, Srinivasan said, "Medium-term inflation expectations remain well anchored as a result of Korea's sound policy frameworks and the forward-looking removal of monetary accommodation." Inflation was 5.6 percent in September, marginally lower than the 5.7 percent in August. In the meantime, the BOK earlier said it was expecting consumer price inflation to remain at around the 5 to 6 percent range "for a considerable time" as the rising greenback acts as extra inflationary pressure.

Krishna Srinivasan, director of the IMF's Asia and Pacific department

The BOK, Korea's central bank which sets the country's benchmark rate policies, has been aggressive in terms of managing interest rate policies by continuing to hike the rate to curb inflationary pressure which has reached the highest level seen in decades. The BOK raised its benchmark rate by 50 basis points last month to 3 percent.

Based on thoughts that the policy priority to contain inflation is appropriate, Srinivasan said that Korea's fiscal policy normalization should continue to support monetary policy.

"As inflation returns to target, the Korean government's medium-to-long-term policy focus should shift to structural reform priorities, including to tackle demographic challenges," he said.

He went on to say that a tighter fiscal policy stance would also help stabilize the level of public debt and safeguard the government's financial health.

"Reinvigorating growth and fostering inclusion requires recalibrating policies to support productivity growth and innovation, providing transitory support amidst reforms to address product, services and labor market rigidities, and ensuring that Korea's human capital remains a central pillar of the transformation process," the IMF official responded.

Korean economy to remain relatively resilient

The IMF director said while the Korean economy is facing a "challenging environment" from a position of strong underlying fundamentals, there is substantial policy space to respond to shocks because of the country's sound institutions and strong track record of economic policy management.

"Korea's external demand conditions are significant drivers of economic growth. Our projection of two-percent growth for the Korean economy for 2023 incorporates the global slowdown projected by the IMF. We expect the Korean economy to remain relatively resilient amidst this challenging global environment, with household consumption and the business investment helping to offset some of the headwinds from exports," he responded.

Because of weakening exports and rising interest rates, the country's economy slowed to a near halt during the third quarter of this year, according to economists. Mainstream thoughts are due to the continued weakness in exports and manufacturing output with the country's top exporters, including Samsung and SK, heavily lowering their factory utilization rate amid high-level inventories, the country's GDP growth will remain sluggish throughout this year.

A currency trader is seen near screens in a foreign exchange dealing room in Seoul, Oct. 26, 2022. AP-Yonhap

Srinivasan advised that policymakers will need to continue responding nimbly to developments as they have done throughout the past few years as well as in response to the pandemic, which permitted Korea to experience a relatively shallow downturn and become the first advanced economy to regain its pre-pandemic level of activity.

Korea has ample foreign reserves

Korea's currency, the won, has declined about 17 percent against the U.S. dollar since the beginning of this year with over 6 percent of that depreciation having happened in the last month alone. The won has been one of the worst performers ― along with the Japanese yen ― in Asia so far this year and the won's weakness raised concerns about the impact of a possible global economic downturn on the country's export-centered economy.

While trade surpluses in Korea and deficits in the United States helped keep a relatively range-bound won-dollar exchange rate over the two decades since the Asian financial crisis, high energy prices are now worsening the country's trade deficit. Plus, the growing interest rate differential with the U.S. Federal Reserve (Fed) rate is also driving down the value of the won, increasing the cost of key imports.

Srinivasan signaled that it's a far-fetched scenario for the country to suffer from a massive capital outflow, given Korea's ample holdings of foreign reserves. As of last month, the country had $416.7 billion worth of foreign reserves, according to data from BOK.

"Korea has a strong external position, including ample FX (foreign reserves), a large net foreign asset position, and a resilient current account that is expected to remain in surplus. And Korea has historically been a part of broad networks of swap lines when there were global dollar liquidity pressures," according to the IMF official.

But he stressed FX intervention "should be used" to help address "disorderly market conditions."

"At this global juncture, keeping market confidence is of utmost importance. In this regard, Korea's coordinated monetary and fiscal policy to contain inflation is key with clear communications about policy goals. The country's close monitoring of market conditions is warranted and welcome," he said. The BOK recently struck a currency swap with the National Pension Service in Korea. But no signs have been seen for the resumption of the currency swap between BOK and the U.S. Fed, said finance ministry officials.

Looking ahead, Srinivasan asked Korean government officials to maintain a solid framework to moderate rising debt issues. "For Korea's public debt position to be strong, given rising public debt over the years, it is important for market confidence that the government maintains a credible medium-term framework underpinned by a solid debt anchor and corresponding fiscal rule," the director responded.

"The country's private debt has grown rapidly, principally driven by the household sector since the start of the pandemic. However, Korea's financial sector is tightly regulated, sound and resilient. Given that house prices increased significantly in recent years in major cities, a moderate and progressive softening in house price growth would help improve affordability and better align valuations with fundamentals," he added.