South Korea Should Raise Interest Rates, Allow Won to Strengthen, IMF Says
South Korea Should Raise Rate
Jean Chung/Bloomberg
Higher energy and food costs pushed South Korea’s inflation a four-month high of 4.7 percent in July, breaching the central bank’s target limit for a seventh straight month.
Higher energy and food costs pushed South Korea’s inflation a four-month high of 4.7 percent in July, breaching the central bank’s target limit for a seventh straight month. Photographer: Jean Chung/Bloomberg
South Korea should raise its benchmark interest rate to at least 4 percent over time and allow its currency to appreciate further to better fight inflation, the International Monetary Fund’s staff said.
“The policy rate hikes thus far, although gradual, are welcome, and should continue in a more decisive manner, given the strong underlying economic momentum and lags in monetary policy,” IMF economists wrote in an annual assessment of the country’s economy released yesterday. “Further two-way exchange rate flexibility would also help in the policy response to inflation.”
The global sell-off in stocks may complicate the Bank of Korea’s decision next week on whether to raise interest rates to tame inflation. Deputy chiefs of South Korean agencies including the central bank are set to meet on Aug. 7 to discuss the global economy and the recent turmoil in world financial markets, the finance ministry said today.
“Given mounting concerns about the global financial market instability led by both U.S. and Europe-led events, it seems difficult for the Bank of Korea to raise its base rate at the August meeting,” said Oh Suk Tae, an economist at SC First Bank Korea Ltd. in Seoul.
The Kospi stock index fell 3.7 percent to 1,943.75 today, the lowest since March 15. The stock gauge has fallen 11 percent in a four-day retreat, the steepest losing streak since November 2008. The won dropped 0.5 percent to 1,067.35 per dollar, according to data compiled by Bloomberg. The currency touched 1,074.49 earlier, the weakest level since June 29.
Inflation Target
Higher energy and food costs pushed South Korea’s inflation to a four-month high of 4.7 percent in July, breaching the central bank’s target limit every month this year.
“Policy interest rates need to eventually rise at the very least to the neutral rate of 4 percent,” from the current rate of 3.25 percent, IMF mission chief to South Korea, Subir Lall, told reporters on a conference call yesterday. “The timing of that is obviously not certain” and is up to bank, he said.
Raising the benchmark interest rate above neutral would bring inflation within target and “safeguard” the central bank’s credibility, according to the IMF report.
South Korea’s real effective exchange rate is undervalued by about 10 percent, the report said. A stronger currency “would help limit the pass-through of imported good prices” to inflation figures, it said.
?Smoothing Operations’
In the report, dated July 14, the IMF staff said that South Korean authorities “considered that the exchange rate is freely determined in the market and that interventions are limited to smoothing operations.” They also “ pointed to the 3.7 percent appreciation against the U.S. dollar so far this year.”
The IMF recommendations were made public after Japanese and Swiss moves over the past two days to weaken their currencies, showing reviving tension in foreign-exchange markets as the deteriorating U.S. economy weighs on the dollar. South Korea’s won climbed to its strongest level in almost three years against the dollar on July 27.
President Lee Myung Bak’s government has waged a “war” on inflation since January through various price control measures and the won’s appreciation. The government raised its inflation estimate for this year to 4 percent from 3 percent in June while cutting its growth forecast to 4.5 percent from 5 percent.
Average Inflation
The IMF, which expects an average inflation of 4.3 percent this year and 3.6 percent in 2012, warned that administrative measures to stabilize prices, if helpful in the short run, “cannot substitute for macroeconomic policies.”
It forecast that the South Korean economy would grow 4.5 percent this year, “above potential,” before easing to a 4.2 percent expansion in 2012.
Capital flow volatility “is likely to remain a concern,” according to the report, which also said that measures taken by the government to temper it “can be more effective if supported by appropriate monetary policy and exchange rate settings.”
To contact the reporter on this story: Sandrine Rastello in Washington at srastello@bloomberg.net; Eunkyung Seo in Seoul at eseo3@bloomberg.net
To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net; Paul Panckhurst at ppanckhurst@bloomberg.net
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