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(News Focus) S. Korea faces uphill fight against inflation
By Lee Youkyung
SEOUL, Jan. 18 (Yonhap) -- Despite concerted government efforts to keep prices down, South Korea faces a tough battle against inflation this year due to fallout from U.S.-led sanctions on Iran and volatile oil prices, economists said Wednesday.

   In a biweekly radio address earlier this week, President Lee Myung-bak reiterated the government's commitment to stabilizing consumer prices within the low 3 percent range as part of its efforts to stabilize the lives of low-income families.

   The stronger rhetoric comes as the Lee administration tries desperately to shore up its sinking public approval rating in its final year in office, with crucial parliamentary and presidential elections to be held this year.

   The South Korean consumer price index rose 4 percent on-year in 2011 after posting a more than 4 percent on-year spike in November and December. The government and the central bank both vowed to contain the consumer inflation rate at 3.3 percent for the whole of 2012.

   However, market analysts and economists expect greater inflationary pressure this year after the U.S. asked its key Asian ally to cut crude oil imports from Iran, in a move which threatens to send oil prices soaring.

   "Oil and sanctions against Iran will be the most urgent and biggest challenge to consumer prices," said Shin Byeong-gill, an economist at Seoul-based Solomon Investment & Securities Co. "A short-term solution seems out of reach. Oil prices may remain a risk factor throughout the whole year."

   Robert Einhorn, the U.S. State Department's special advisor for nonproliferation, urged South Korea and other U.S. partners to reduce crude oil purchases from Iran during his three-day trip to Seoul this week.

   The U.S. request, aimed at ratcheting up international pressure on Iran's alleged nuclear weapons program, is likely to become an additional drag on South Korea's increasingly unpopular president, whose single, five-year term ends early next year.

   The South Korean government is weighing options on how to collaborate with its close military ally, while reducing any impact cutting oil imports will have on the local economy. South Korea imports some 10 percent of its crude oil needs from Tehran.

   Bank of Korea (BOK) Gov. Kim Choong-soo said Friday that rising tension between Tehran and Washington is an upside risk to the central bank's consumer price goal, though he did not revise the central bank's consumer price forecast.

   Demand from emerging countries could also stoke global crude oil prices, said Park Ki-hong, an economist at Korea Exchange Bank. Higher oil prices fuel inflation by raising the price of imported goods and the costs of raw materials that use oil.

   On the domestic front, there also lurk several factors unfavorable to the government's efforts to curb inflation, analysts said.

   South Korea's finance ministry has allocated 70 percent of its budget to the first half of this year and aims to execute 60 percent of it during the first six months in a bid to stimulate the stagnant growth with hefty public spending.

   The state-run Korea Institute of Public Finance estimates that executing 60 percent of the annual government budget during the first half of this year will increase consumer prices by 0.3 percentage point, compared with the even execution of its budget between the first and the second half.

   In addition, the country will hold its two major polls in the same year, which may offer fertile ground for populist policies to take root. When parliamentary and presidential elections were previously held in the same year, market liquidity tended to show a 5.5 percent increase from the previous year, according to a recent study by Shinyoung Securities of the money supply in South Korea since 1960.

   Some economists downplay the impact of heavy government spending and elections on consumer prices.

   Others, however, argue the combination of external and internal factors this year -- uncertain oil prices, front-loading of the government budget and elections -- could have annual consumer prices breaching the government target.
Elections and declining support for the ruling party and the president could also complicate the central bank's efforts to rein in inflation through its rate policy, as raising borrowing costs could burden low-income families, analysts said.

   South Korea's household debts stood at 638 trillion won (US$554.4 billion) as of the end of November as low-income earners increased borrowing to support daily necessities alongside a squeeze in income and jobs.

   "Despite high consumer prices, it will be difficult for the BOK to hike key interest rates because of household debts," Ryan Oh, a Samsung Securities fixed-income analyst. "I think there is also a political reason as higher borrowing costs could negatively affect elections."

   BOK's Kim, a former economic advisor to the president, is still seen as a close political ally of Lee's by critics who worry about the central bank's independence.

   The central bank's monetary policy committee froze the key interest rate at 3.25 percent in January for the seventh straight month, citing higher risks from Europe's fiscal crisis.

   There is also lingering suspicion over whether the government's efforts to curtail inflation can prop up domestic spending, which has become all the more important for the South Korean economy this year as Europe's fiscal crisis is feared to dampen its export-dependent economy.

   Given last year's high inflation and the subsequent base effect, the on-year gain in consumer prices in 2012 could be moderate.

   However, the month-on-month data shows a continuing rise in inflation and consumers are unlikely to think prices are easing, analysts said.

   "It may be easy for the government to meet the inflation target," said Shin, the Solomon economist. "But that does not mean consumer prices are low enough to make consumers boost spending."