The Bank of Korea should keep its benchmark interest rate unchanged as escalating military tension with North Korea and Europe’s debt crisis have shaken investors’ confidence, the head of a state-run research institute said.
“It’s not a good idea to raise rates now,” Hyun Oh Seok, president of the Korea Development Institute, said in a May 26 interview in Seoul. “It will only stir more turmoil.”
Pressure on the central bank to raise rates has been increasing as growth accelerates and policy makers from India to China tighten monetary policy. The Bank of Korea on May 12 dropped the phrase “for the time being” from its yearlong commitment to keep an easy policy stance.
“It remains to be seen how the North Korean issue and the European case develop and affect our economy,” said Hyun, a key economic adviser to policy makers at the central bank and in the government. “I’m much more concerned about the possible fallout of the debt crisis in southern Europe as it could jeopardize the still fragile global economic recovery.”
The bank needs to draw up well-designed exit strategies to contain inflation as the key rate is very low and the economy is approaching its growth potential, Hyun said. He said the “normalization” of rates should be done at a gradual pace. The bank cut the rate to a record-low 2 percent in February 2009.
South Korean government officials have repeatedly said that it’s “too soon” to raise borrowing costs as the economy still faces many uncertainties, including Greece’s debt crisis.
Hyun said he expects the economy will grow 5.9 percent this year on strong exports and domestic demand. It expanded a faster-than-expected 1.8 percent in the first quarter and the Bank of Korea projects 2010 growth of 5.2 percent.
“Our economy is very robust and resilient,” Hyun said. “The government should try to earn more confidence from investors with consistent and predictable policies.”
Inflation pressure will build up fast “soon” as the domestic economy strengthens and a recovering global economy drives up raw material prices and other costs, Hyun said.
Inflation will reach 3 percent this year from 2.8 percent in 2009, the institute forecast. That would still be within the central bank’s target range of between 2 percent and 4 percent on average for the three years to 2012.
The won will likely regain its strength once Europe finds some stability and investors return to looking at economic fundamentals, Hyun said, calling for a careful approach when the government intervenes in the market.
“The general trends are for a firmer won,” said Hyun. “Both the foreign-exchange authorities and investors should decide whether its recent decline was caused by economic fundamentals or one-time passing events.”
The currency plunged to a 10-month low this week after a defector group reported North Korea’s military was ordered to prepare for combat on May 20, when South Korea said its communist neighbor was responsible for the March sinking of a warship in which 46 sailors lost their lives.
South Korea’s government and central bank pledged coordinated action on May 26 to keep the won stable, promising to take prompt measures including supplying sufficient foreign liquidity. The commitment helped to ease the slide in the won.