Inflation-adjusted Interest Rate Becomes Zero

Bank of Korea Governor Lee Ju-yeol presides over a Monetary Policy Committee meeting in the morning of May 28.

The Bank of Korea cut the key rate by 0.25 percentage point on May 28. As a result, the interest rate reflecting the rate of inflation, 0.3 percent to 0.6 percent, has become zero.

Since the central bank cut the key rate two months ago, the market liquidity has increased a lot and the South Korean government has poured 245 trillion won as fiscal and financial resources. Nevertheless, a real economic recession caused by COVID-19 is still going on.

In the meantime, the money has flowed into asset markets such as stock and real estate. KOSPI topped 2,000 points in 81 days on May 27 and new high house transaction prices have been reported in districts in Seoul such as Gangnam. In the first quarter, the total household debt hit an all-time high of 1,522 trillion won. Under the circumstances, more and more economists are pointing out that asset bubbles attributable to the excessive liquidity may lead to a depression.

In the wake of the COVID-19 outbreak, South Korea is likely to record a trade deficit this month as well as last month and its international creditworthiness is likely to fall. In addition, foreign capital outflow is imminent due to the zero interest rate. The value of the South Korean currency is falling at a rapid pace. The won-dollar exchange rate topped 1,240 won per U.S. dollar on May 28.

That day, the Bank of Korea lowered its domestic economic growth forecast for this year to negative 0.2 percent, down no less than 2.3 percentage points in just three months. It warned that the South Korean economy might show negative growth for the first time since 1998 due to the economic impact of COVID-19. The bank also lowered its consumer inflation estimate from 1 percent to 0.3 percent.

In the central bank’s best-case COVID-19 scenario, the annual economic growth is estimated at 0.5 percent for this year and 3.8 percent for next year. In the worst, the figures are negative 1.8 percent and 1.6 percent, respectively.

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