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Economics – Markets – Strategy
Economics: Korea
moving ahead of the curve (Chart 6). Last year for instance, they hiked rates as
early as 3Q07 when growth had risen above potential for merely one quarter,
and inflation stayed fairly stable at the lower-end of policy target (2.5-3.5%).
Thanks to the well-controlled consumer prices last year (2.5%), the inflation
average from Jan07 to May08 is 3.0%, only at the middle point of the policy
target (which is set for inflation average in 2007-2009). Indeed, a forward-looking
central bank should understand that cost-push inflation will unlikely sustain
very long as growth will also be dragged. The BOK is likely to make rate decision
based on growth trend, more than the lagging inflation data.
The BOK is likely to
focus more on
growth than on
inflation
Meanwhile, recent years of strong capital inflows, currency intervention and
monetary sterilization have left the BOK with large amount of foreign reserves
(27% of GDP, vs. 6% in 1996) and monetary stabilization bonds (17% of GDP, vs.
4% in 1996) (Chart 7). It appears that the BOK has injected liquidity into financial
system ever since 4Q07 to tame the rises in market interest rates, as evidenced
by the gradual declines in the amount of outstanding MSBs (Chart 8). Also, the
Chart 7: The BOK has the capacity of intervention
%
35
Foreign Reserve / GDP
30
MSBs / GDP
25
20
15
Chart 8: The BOK discharging liquidity
won trn
200
150
100
10
5
50
Outstanding MSBs
0
1991 1993 1995 1997 1999 2001 2003 2005 2007
0
Apr-98 Apr-00 Apr-02 Apr-04 Apr-06 Apr-08
BOK has the capacity to intervene the FX market and prevent the won from
excessive depreciation, if required. In fact, the won’s sharp drop in March-May
was partly fuelled by the government’s earlier enthusiasm of using a weaker
won to stimulate exports. Since the BOK heavily intervened in late-May and
the government reduced the talks on the benefits of a weaker won, the won/
dollar rate has stabilized.
Overall, we think Korea still has sufficient fiscal and monetary instruments to
help it survive the current difficulties. Growth is likely to remain low this quarter
and the next given the prevailing external and internal headwinds. The timing
of a recovery would largely hinge on the implementation of fiscal stimulus,
and BOK policies. We downgraded 2008 GDP growth forecast to 4.6% from
4.8%, but maintain 2009 forecast at an above-potential 5.0% for now.
The timing of
growth recovery
hinges on the
implementation of
fiscal stimulus
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