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(News Focus) S. Korea's rate cut forecast to prop up growth

All Headlines 15:05 June 11, 2015

By Lee Joon-seung

SEOUL, June 11 (Yonhap) -- South Korea's blitzkrieg interest rate cut is expected to help bolster the struggling economy and resuscitate consumer confidence hit by the outbreak of a potentially fatal respiratory disease, analysts said Thursday.

In a monthly policy meeting, the central Bank of Korea slashed the base rate by a quarter percentage point to a record low of 1.5 percent in a bid to help ease the fallout of the Middle East Respiratory Syndrome (MERS) outbreak on Asia's fourth-largest economy.

Market analysts and economists said that the rate cut is the right step at this juncture as the spread of MERS is starting to adversely affect consumer spending, a key driver of the nation's economy together with exports.

Data showed credit card use falling 5.5 percent on-month in the first week of June, with sales at large discount outlets and department stores dropping even faster. Department stores and discount outlets saw sales nosedive 25 percent and 7.2 percent, respectively, early this month vis-a-vis the first two weeks of May.

Since the first confirmed case on May 20, nine people have died and more than 3,800 people have been quarantined with the number of people testing positive for MERS hitting 122. This is the second-highest number of infections after Saudi Arabia, which first reported the illness in 2012.

"Lowering rates will not immediately impact business investment and spending because of the natural lag time, but it can improve consumer and business sentiment to some extent," said Bae Sang-keun, deputy head of the private Korea Economic Research Institute.

The rate cut will not only make it cheaper to pay interest on loans but also lower the value of the Korean won, which is good news for local exporters that have been hard pressed coping with the weak Japanese yen and euro.

This view was echoed by the Korea International Trade Association, and insiders from the information technology (IT) sector and auto industry, who forecast that South Korean companies should be able to gain price competitiveness in overseas markets.

"A rate cut can influence foreign exchange rates and can ease the interest payment burden which is a plus for companies," a source in the IT sector said.

Carmakers such as Hyundai Motor Co., pointed out that 90 percent of all car sales involve some sort of auto financing, saying the rate reduction can induce more people to buy new vehicles down the road.

Airlines and shipping companies, who usually have more debt than firms in other industries, said the key rate cut from 1.75 percent to 1.5 percent is expected to help ease their interest payment burdens.

Lower borrowing costs are also projected to fuel growth in the housing market that has witnessed a surge in home transactions in recent months.

"Already low interest rates are fueling the purchase of new homes, with the latest move expected to bolster this trend," a local real estate market researcher said.

With demand likely to go up, there is a good chance that local construction companies will build more homes down the line, he added.

The construction sector is an important source of jobs, which is vital for sustainable growth.

Local experts, meanwhile, said that while the rate cut is an appropriate measure, it should be supported by a supplementary budget in order to help the economy gather growth momentum, as the government has done several times in the past.

Lee Jun-hyup, a research fellow at Hyundai Research Institute, said the rate cut came at a time when domestic recovery remains weak and exports are contracting.

"There is a pressing need to engage in an even greater expansionary fiscal policy that includes extra budget," he claimed.

Park Jong-yeon, an analyst at NH Investment & Securities, said the BOK's action reflects concerns that the Korean economy may not be able to pull off 3 percent growth this year, particularly in light of the MERS outbreak.

In early April, the central bank forecast the economy to grow 3.1 percent this year, down from a 3.3 percent expansion in 2014, but there have been signs that actual growth may not even make the 3 percent mark.

"Lowering the country's interest rate is helpful, but what is really needed is more cash reaching the market as soon as possible," Park said.

On the downside, many experts stressed that there is a need to control household debt, which is already growing at a very rapid pace. They say the rate cut could compound the problem, which would pose challenges for the financial sector if there is a sudden shock.

In addition, the rate reduction is feared to hurt people who live on interest generated by deposits.

According to the experts, low interest also means that more and more home owners will want to receive monthly rent instead of offering tenants "jeonse".

Jeonse is a system where the tenant gives the home owner a lump sum of money to lease a home without paying regular rent. The money is then returned after the lease expires.

"This development can force low-income families out of their existing homes or force them to switch to monthly rent, which can eat into their income," a housing market insider said.

Some market analysts said that policymakers need to be careful about asking for a supplementary budget because it can increase the nation's budget deficit.

South Korea's central government debt stands at around 40 percent of gross domestic product, which is very low compared to more than 100 for the United States and 200 percent for Japan. However, the country is in the process of increasing welfare outlays and must prepare for the rapid aging of the population that will compel more spending.


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