Dear Bank of Korea: NOW Is The Time For Higher Interest Rates

Now Is The Time to Raise Korean Interest Rates
The Bank of Korea has a very difficult job to do. It gets buffeted from every direction. It is highly dependent on imports on many different levels. Food and energy are two very important imports which Koreans depend upon everyday. The prices of both have rocketed as the result of a list too long to detail here. Middle East tension, foot and mouth disease, increasing China demand are just three of the largest, but that is by no means an exhaustive list. A weak Korean Won makes each of these more expensive because they are priced using dollars or other foreign currencies. The result? Inflation. Korea has had the highest food inflation in the OECD over the past 12 months. So, the relatively weak Korean won has made the impact of globally rising prices worse.

Higher Interest Rates Presents Difficulties:
On the other hand, higher interest rates would lead to a stronger Korean Won. That also would lead to difficulties. Household borrowing remains very high in Korea. Higher interest rates would mean more interest costs that would need to be paid by Korean consumers. Higher interest rates would lead to lower real estate prices, which have suffered in Korea due to oversupply, changing tax laws, and a myriad of other reasons. All else equal, a stronger Korean Won would also lead to less competitiveness in international markets.

Japan’s Tragedy Has Strengthened the Yen
There is no other way to state it: Japan faces an unprecedented rebuilding effort. It will be costly, and some estimates suggest it will cost something like $300 Billion. The question is: where is that money? For Japanese companies, people, and foreigners, that money will come from overseas, who will sell their currency, and buy the Yen. That will make the Yen stronger. In addition, the current geopolitical issues make the Yen a “safe haven” currency for speculators. The Seoul Gyopo Guide has explained how this has helped Korea enormously. The Bank of Korea has intentionally kept the Korean Won weak, which has resulted in outsized gains in profits and market share for Korean companies’ products. Those market share gains have now been cemented, i.e. Hyundai Motors, Samsung Electronics, LG Electronics, and other Korean-made products are now among the world leaders. However, at this point, the Japanese situation, and the amount of resources and effort necessary to help Japan will dominate everything. The speculators will come and go, but the rebuilding effort will remain for years to come. In short, the pressure to increase the value of the Yen because of the necessity of funds will overwhelm everything. That presents the Bank of Korea with the opportunity necessary to help the inflation situation.

Acceleration of Interest Rates Will Help Tame Inflation
The negative effects that usually accompany a stronger Korean Won do not apply because the key foreign exchange rate is the JPY/KRW. That is currently at 14, which is only 25% stronger than its absolute worst levels of the financial crisis beginning in 2007. Raising interest rates will strengthen the Korean Won compared to foreign currencies which will help pay for the foreign imports such as oil and food imports. At the same time, international competitiveness will not be significantly hurt, because the Yen is so strong. A stronger Korean Won would still not hurt Korean products’ competitiveness. Other industries, other than tourism, will not be significantly hurt. Will real estate continue to suffer? Yes. Will consumer debt remain an issue? Yes. However, lower inflation may curb the amount of money necessary to borrow for food and energy.

Is It That Obvious? It NEVER Is
The FX/Interest Rate/Inflation situation in Korea has been difficult, and will remain to be for the medium-term. The fact is that the Bank of Korea will need to keep its eye on the balance of a dizzying amount of factors. Fortunately, it has ignored rants from others for the most part. The Seoul Gyopo Guide has defended the Bank of Korea, but now calls on the BOK to raise rates to address the nation’s inflation problem, before it gets even worse. The situation in Japan has now made this possible. Finally, there is one other benefit to an increase in interest rates: it will lessen the difficulty on the Japanese economy, its companies, and its people, because there will be pressure on Japanese corporate profits resulting from production stoppages, etc. While that is not the Bank of Korea’s responsibility, it would be a welcome unintended consequence of an interest rate increase.