[INTERVIEW] Korea unlikely to suffer drastic capital outflow: S&P

This article is the first in a three-part series of interviews with chief economists covering the Korean economy at the Big Three credit rating agencies to analyze the state of Asia's fourth-largest economy amid rising interest rates and high inflation _ ED.

Recovery in domestic demand stronger than expected

By Kim Yoo-chul

A faster-than-expected U.S. monetary tightening has heightened jitters across global financial markets, while market observers here are paying keen attention to whether such volatility will lead to a sudden capital outflow from Korea.

Capital outflows happen when various types of assets and real money move to another country attracted by favorable investment returns, such as higher interest rates.

The central Bank of Korea (BOK) is facing mounting pressure to move much faster to address growing concerns of capital outflows as the won weakens against the USD and the U.S. Federal Reserve (Fed) continues to take big steps in hiking rates.

S&P Global Ratings Asia-Pacific Chief Economist Louis Kuijs

The Fed is widely seen to be heading toward more aggressive rate hikes. That means the U.S. interest rate could end up becoming higher than Korea's. That could eventually trigger capital outflows from here, policymakers and economists have said. After hiking its benchmark rate by 75 basis points in June, the Fed is set to conduct another large-scale rate increase at its scheduled July monetary meeting because U.S. inflation has reached a four-decade high of 9.1 percent.

The BOK's benchmark rate is now at 2.25 percent, while the Fed recently lifted the U.S. interest rate by 75 basis points to between 1.50 and 1.75 percent.

Speaking to The Korea Times, Standard and Poor's (S&P) Global Ratings Asia-Pacific Chief Economist Louis Kuijs said Korea is not in a position to suffer from any drastic capital outflows because the country's inflation level is not as high as that of the United States.

"The Fed is likely to raise its policy rate substantially in the rest of 2022 and first half of 2023. While Korea's inflation is rising, it is not as high as in the U.S. Thus, from a domestic point of view, the BOK may not need to raise its policy rate as much as the U.S. Fed. If, as has been the case so far, capital outflows and won depreciation remain gradual and manageable, the combination of relatively low interest rates in Korea and the depreciating currency may be an acceptable scenario for the BOK," the chief economist said in a recent interview.

In this photo provided by the Bank of Korea (BOK), U.S. Treasury Secretary Janet Yellen speaks during a meeting with economists who work at the BOK in Seoul, July 19. AP-Yonhap

He said that Korea's central bank may try to raise its rates "over and above" if the depreciation of the local currency ― the won ― accelerates. Finance ministry officials have been saying that Korea will avoid capital outflows only because of a rate differential with the U.S. Fed. However, the local currency has already lost more than 9 percent of its value against the U.S. dollar so far this year.

A weakening won typically deteriorates the balance of trade because the trend drives up the price of core raw materials such as energy, food and others. Korea relies heavily on imports of these necessary components. Finance Minister Choo Kyung-ho agreed with U.S. Treasury Secretary Janet Yellen to cooperate in helping stabilize the foreign currency market and apply actions such as liquidity facilities, but only if necessary. Korea's $60-billion currency swap line with the United States expired last year.

"We have the policy rate for Korea ending 2022 at 2.25 percent and 2023 at 2.5 percent. It is too early to say whether that will be enough to rein in inflation. But we expect that an easing of global energy and commodity price increases, a slowing economy and the impact of higher interest rates should be enough to rein in inflation," according to him.

Financial stability

Kuijs stressed that while capital outflows have so far remained modest, financial instability could become more of a concern as the BOK is collaborating with financial regulators for coordinated policy efforts to lessen the debt burden on low-income households.

Also, it has become more difficult for monetary policymakers to fulfill their role as the country's record household debt level and slowing export growth momentum are viewed as core factors behind the BOK's reluctance to hike rates drastically. In June, Korea suffered its lowest export growth in 19 months, adding to concerns about the soundness of the economy.

A news ticker on a building displays the latest information on surging inflation as pedestrians pass through Times Square, July 14, in New York. AP-Yonhap

"There will be a limit to the degree the BOK can ease monetary policy. However, as noted, the weaker that growth will be, the more inflation pressures will ease. That should create some room for a less tight policy stance if needed. If downward pressure on growth persists, the BOK will need to weigh the desire to support growth against the need to tighten policy to anchor inflation expectations and head off financial instability," according to him.

Kuijs said the S&P expects the country's consumer price index (CPI) to rise further "in the coming months." However, he stressed that the intensity of inflation should abate during the remainder of this year. "Later in the year, less unfavorable 'base effects,' an easing of energy price increases, a slowing economy and the impact of earlier interest rate increases should start to bring down consumer inflation. Barring new energy and commodity price hikes, inflation should be below 3 percent again in 2023," he responded, saying the rise in "core inflation" has led the BOK to start increasing interest rates to constrain demand and contain inflation expectations.

Core inflation is defined as the change in the costs of goods and services minus food and energy, as food and energy prices are too volatile and/or fluctuate rapidly. The country's consumer price index rose 6 percent in June, year-on-year. However, the core inflation rate remained at 4 percent.

"The current round of global inflation was initially largely triggered by high energy and other commodity prices as well as supply chain constraints. If inflation expectations remain well-anchored, such 'cost push' inflation is likely to pass without driving up CPI inflation for more than a transitory period. However, as was the case in the U.S. earlier on, core inflation started to rise in Korea in late 2021, implying that firms started to pass on cost increases and wages began to increase to offset the price rises," he said.

Kuijs said there is a possibility of Korea's growth outlook being revised up, but only if the Ukraine crisis eases or growth in the United States, Europe and/or China turns out better than currently expected.

"But if the headwinds intensify, we may have to lower our projection … the recovery in Korea's domestic demand has been somewhat stronger than we expected, leaving our overall GDP growth forecast for Korea unchanged," the S&P Global Ratings Asia-Pacific chief economist said.

In a recently-released economic assessment report known as the Green Book, Korea's finance ministry said the country's economy is feared to be slowing down because of rising inflationary pressure and slowing export growth.