Rising Interest Rates & High Debt Levels: A Bad Combination
The Seoul Gyopo Guide has been pointing out two areas of concern for the Korean economy: lower real estate prices and heavy indebtedness occurring as a result of inflation the high cost of living. The Dong-A Ilbo pointed out that indebtedness in Korea has soared.
Bank of Korea’s Difficult Task Continues
The Bank of Korea (BOK) has had an unenviable task. Inflation has increased, in part because import prices are high. Why is that? The Korean Won is weak. However, that same, weak Korean Won encourages exports of Korean-made products. Usually, central banks use the level of interest rates to dampen inflation. The BOK has been widely expected to continue to increase interest rates. However, at the same time, the BOK has been believed to have been intervening in the foreign exchange markets in order to weaken the Won. In short, the Bank of Korea is in between a rock and a hard place. Recent actions suggest that the BOK is trying to have it both ways.
Long, Complicated Laundry List of Issues
Real estate prices in Korea have declined even as the global economy has struggled to improve. The single most important factor in determining real estate prices? Interest rates. As interest rates rise, real estate prices decline. If the price of your home declined, would you feel more or less confident in purchasing items? Less confident. The Bank of Korea is fully aware of this.
Household borrowing is high, and an increase in interest rates will make things worse. The reason is that household debt is tied to the level of interest rates.
Corporate and public sector indebtedness is high. An increase in interest rates will make the situation worse, not better as the interest costs borne by Korean companies, and state-sponsored enterprises increases.
The question is whether or not inflation will decline by enough to offset the effects listed.
BOK Should Stop Selling the Won
The Bank of Korea should stop selling the Won in international markets. While this will hurt Korean companies’ products in the international marketplace, the fact is that Korean products are now amongst the most competitive in the world. In addition, many of the products’ competitors are Japanese. Well, if you didn’t know, the Japanese have a slightly larger problem at hand. Allowing the Korean Won to rise will relieve some of the inflationary pressure in Korea. Not raising rates will ease the pressure on high indebtedness. Whether or not this combination can be sustained is unclear. However, the Bank of Korea’s intervention in foreign exchange markets isn’t really helping matters. In any case, the BOK’s task will not get any easier soon.