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(EDITORIAL from the Korea Herald on Sept. 4)
Room for rate hikes
Describing Korea's monetary stance as "highly accommodative," the International Monetary Fund has advised Seoul's monetary authorities to gradually raise the policy interest rate by as much as 200 basis points from the current 2.25 percent. It is unusual that the fund suggested such a large hike in the policy rate.
In its annual report on the Korean economy, the fund offered an upbeat outlook. It raised Korea's growth estimate for 2010 to 6.1 percent, up 0.35 percentage points from 5.75 percent it suggested just two months ago.
In the fund's view, the Korean economy is already at or close to its potential level. Therefore, it is the right time for the government to exit from supportive measures, especially from an overly expansionary monetary policy.
To make its call for rate hikes more convincing, the fund estimated the neutral interest rate for Korea. A neutral interest rate refers to the rate which would prevail when an economy reaches its potential growth rate under stable inflation. The fund’s conclusion is that Korea's current policy rate is well below the neutral rate by around 200 basis points.
The Bank of Korea raised the benchmark rate by 25 basis points in July after keeping it at a record low 2 percent since February 2009. As inflation has begun to show signs of accelerating, the bank needs to continue the tightening cycle and prevent inflation building. Last week, BOK Governor Kim Choong-soo strongly hinted at a rate hike, saying that July's quarter-point rate increase might not be sufficient to curb inflationary pressures. We expect him to take the fund's recommendation seriously in setting the benchmark rate this month and beyond.
Together with the large rate adjustment, the IMF also made an unusual recommendation: it advised the Ministry of Strategy and Finance review its recent practice of attending monetary policy meetings and voicing views publicly on the appropriate monetary policy stance. It said ensuring the independence of the monetary authorities would help strengthen their credibility.
The fund's specific reference to the ministry's attendance at the Bank of Korea's rate-setting meetings seems to suggest that Seoul's highly accommodative monetary stance is the result of the ministry's intervention.
The ministry justified its presence at the meetings, saying some advanced countries like the United Kingdom and Japan also implement similar practices. We side with the fund. Our view is that the ministry's attendance is an affront to the expertise and judgment of the Monetary Policy Committee members.
The fund's report rightly emphasizes the need for Korean policymakers to shift their focus from crisis management to structural reforms to ensure the economy's sustained growth and resilience to external shocks over the medium term. This task calls for tackling such tough challenges as raising the productivity of the nontradable sector and restructuring troubled small and medium-sized enterprises.
The recent crisis has shown the risks of an economy flying with a single engine -- exports. To sustain growth and minimize the impact of external crises, Korea needs to develop a second growth engine -- the nontradable sector. For this, policymakers need to take bolder reforms, including opening up service industries for competition.
At the same time, it is necessary to restructure or liquidate troubled SMEs, another drag on productivity growth. Currently, banks are selecting SMEs which have trouble in servicing their debts. But they tend to be too lenient in the screening process as liquidating insolvent firms would increase their losses. Policymakers need to monitor the bank-led restructuring process more closely to make sure that banks do not keep zombie firms alive through evergreening.
(END)
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