The Bank of Korea is stuck in an interest rate trap. An increasing pressure is being put on the central bank with more and more economic indicators sending negative signals but global financial uncertainties are blocking it from cutting the key interest rate for economic stimulus.
The central bank announced on March 2 that the sum of foreign securities and bond investment in Korea and Korean enterprises’ overseas securities and bond issue is estimated to have recorded a net outflow of US$4.525 billion in January this year. The downturn started in June last year and continued for eight months in a row. During the eight months, the total net outflow amounted to US$23.387 billion, equivalent to 76.1% of the amount recorded during the global financial crisis in 2008. In 2008, a decline in foreign securities investment continued from June to November.
For the first two months of this year, no less than 4.05 trillion won flowed out of the domestic stock and bond markets. Although the stock market posted a slight net inflow in February after a net outflow of whopping 3.16 trillion won in the previous month, the capital outflow continued in the bond market, where foreign investors took out 1.65 trillion won in February alone.
Under the circumstances, the won-dollar exchange rate is soaring. Between December 30, 2015 and February 29 this year, the rate rose from 1,172.5 won per U.S. dollar to 1,236.7 won per U.S. dollar. The exchange rate volatility is on the increase as well along with China’s influence on the global financial market. On March 2, the won-dollar exchange rate fell 9.2 won from a day ago to 1,227.5 won per U.S. dollar immediately after China cut its reserve ratio.
Some experts point out that the Bank of Korea is in no position to cut the benchmark rate when global financial market uncertainties and concerns over capital outflow are taken into account. The others are saying that the central bank is unlikely to do so even after the capital outflow subsides because a rate cut for domestic economic stimulus could trigger another capital outflow with global uncertainties remaining. Besides, it is not sure whether the domestic demand will revive based on a risky rate cut.