Korean Government Paying Sharp Attention to Fed’s Exit Strategy

Federal Reserve Chairman Ben Ber­nanke mentioned the monetary policy for exit strategy in the end. Korean eco­nomic experts expressed their concerns over possible short-term volatility in the financial market while predicting that the recovery of the US economy would act in favor of the export-driven Korean econ­omy down the road. At the same time, some predicted that the global economy could fall into a double dip if the exit strategy went awry due to a failure of communication among market partici­pants, and poor policy timing, etc. It was warned that the interest rate shock could also affect marginal firms and indebted households.

Worse-case Scenario: Double Dip

As of now, the consensus is that the exit strategy has been derived from the predominance of positive pros­pects for the US economy. The demand side’s picking up to result in increased imports can have a positive effect on Korea’s export to the US market. This can improve the current account bal­ance along with a rise in the exchange rate, which, in turn, can make the Korean economy look more attractive in the sec­ond half of this year. 

Still, some people are raising con­cerns that the upward adjustment of the interest rate could exacerbate the prob­lem of household liabilities here. “The rate increase is likely to affect the real economy, households with debt in par­ticular, to cause a decline in spending,” said Jeong Yeong-shik, an analyst at the Samsung Economic Research Institute. He continued, “Furthermore, it will bring about higher financing costs on the part of enterprises and aggravate the liquid­ity problem in the shipbuilding, shipping, and construction sectors, etc.”

A faster-than-expected pace of tight monetary policy could give rise to simul­taneous interest rate hikes around the world and a double dip. This is why local experts are calling upon the government to strengthen its monitoring of the capital market. “The authorities should watch the capital market more closely rather than focusing on regulations for the soundness of the foreign exchange market,” Korea Development Institute researcher Kim Seong-tae explained, adding, “The gov­ernment will also have to come up with contingency plans in order to provide against sudden capital outflow.”

Financial Companies Expecting Fi­nancial Crunch to Be Eased

In the meantime, financial companies are busy calculating pluses and minuses on their part. Both banks and insurers are having trouble these days due to the low interest rate and the drop in profits result­ing from it. Significant attention is being paid to whether the Fed’s exit strategy will provide breathing space. 
As far as banks are concerned, the lending rate is likely to go up faster than the deposit rate and they will be able to enjoy some profits in the short-term. However, the risks borne by households and corporations could increase at the same time, which means things have to be watched at least for some time. Insur­ers, meanwhile, are drawing a rosy pic­ture in that their main investment targets include treasury bonds. 

Banks Face Risks of Bad Loans 

Most local banks raised their con­forming loan rates by 0.4 percentage points recently. The move can be a boon to their profits, yet the problem is that the loans have the possibility of becoming insolvent. 

“When the interest rate goes up, companies and households have to pay more interest and this could affect the fis­cal soundness of banking institutions,” said Dr. Im Jin at the Korea Institute of Finance (KIF), advising financial firms to not simply focus on the loan-deposit spread. Director Park Seong-wook at the KIF’s Macroeconomic & International Finance Division echoed this, saying, “Probably, banks with bonds will face capital losses and tighter foreign curren­cy conditions, making risk management more difficult than it is now.” It appears that what is crucial is the pace of the interest rate change. 

Insurers Need to Keep Low Interest Rate Stance 

Local life insurance firms’ operating profit rate fell to 3.24% late last year, no less than 0.84 percentage points from a year earlier. The drop was caused by the earnings rate of the asset management division that dipped below 5%. In this vein, the exit strategy can be a favorable fac­tor as it means larger room for asset man­agement. 

Nevertheless, some insurers could turn various assets into available-for-sale (AFS) securities subject to the mar­ket price valuation method and the inter­est rate rise could decrease the size of their assets. “The bond rate increase is likely to reduce their reverse margin, but some insurers who convert their securi­ties into AFS will face difficulties,” said Dr. Kim Hae-shik of the Korea Insurance Research Institute. He went on, “With the movement of the interest rate having yet to decide on its direction, they need to maintain the low interest stance at least for a while and a hasty pursuit of larger investment profits will entail high risks.”

Government Working on Financial Market Risk Index for Scenario-spe­cific Response 

The government is closely watch­ing the potential aftermath of the pol­icy. “We’ll carry out prepared counter­measures while monitoring the market response,” said Choi Hee-nam, who is heading the International Finance Policy Bureau of the Ministry of Strategy and Finance. Specifically, the ministry will draw up its own financial market risk index based on the exchange rate, treasury bond rate, credit default swap (CDS) pre­mium, foreign currency outflow, and so on, while addressing the situation with phase-by-phase plans. It has already pre­pared action plans to deal with situations in which the real economy recovers amid foreign currency outflow, and capital outflow if the real economy fails to gain speed, etc. It is also planning to expand currency swaps with the central banks of major economies and shore up the multi­national financial safety net, such as the Chiang Mai Initiative.

The authorities believe the current situation is unlikely to result in the per­fect storm that was seen during the global financial crisis of 2008. “The implica­tion of the end of the quantitative easing policy shows that the US economy is on a recovery track,” the director explained, adding, “Korea, with its decent econom­ic financials, will take a smaller hit than those countries that are highly dependent on raw material exports or those that have huge current account deficits, that is, a worldwide liquidity crisis is not like­ly at this time, unlike five years ago.”