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Korea May Be Forced to Use Unconventional Stimulus For Economy Hit by Trade War

Korea May Be Forced to Use Unconventional Stimulus For Economy Hit by Trade War

(Bloomberg) -- With its interest rates back at an all-time low, speculation is mounting that the Bank of Korea may be forced to join other central banks in using unconventional tools to stimulate one of the hardest-hit economies in the trade war.

While Governor Lee Ju-yeol said last week it was too early to consider unconventional steps, he also acknowledged that the BOK was constantly reviewing and updating its “contingency plans” and studying actions previously taken by other nations should it run out of room to lower interest rates.

Korea May Be Forced to Use Unconventional Stimulus For Economy Hit by Trade War

“When the down cycle comes and monetary stimulus comes to the rescue, Korea is no exception,” said Tao Dong, managing director of Credit Suisse Private Banking Asia-Pacific.

Even as Lee seemed to play down near-term prospects for quantitative easing after last week’s board meeting where the key rate was cut to 1.25%, economists have been busy game planning how unconventional policy could play out in Korea. Potential measures, according to more than a dozen analysts reached for this story, could include relatively easy-to-implement ones like bond purchases, cheap funding and forward guidance to more controversial ones like stock purchases, negative interest rates and mortgage support.

Korea May Be Forced to Use Unconventional Stimulus For Economy Hit by Trade War

Asset Purchases

South Korea’s law already provides a broad remit for the BOK to buy stocks and bonds as part of its monetary policy, while leaving out a mention of the maturity of bonds that can be traded. During the global financial crisis in 2008, the BOK purchased 1 trillion won ($850 million) of three to 10-year government bonds and extended low-interest loans to companies via commercial banks.

“It may not be reluctant to adopt similar measures in the event of future economic shocks,” said Tieying Ma, an economist with DBS Bank, expecting the BOK to hold off from such steps until its benchmark interest rate is 1% or lower.

Asked about the BOK’s so-called effective lower bound, most economists said the board would probably lower its rate to somewhere between 0.5% and 1% before opting for unconventional measures.

Analysts are split on the BOK’s next step after last week’s reduction, with some seeing a hold throughout 2020, and others seeing a cut to 1% or 0.75%.

Adopting forward guidance, such as an assurance that rates would stay low, is something the BOK could consider because it doesn’t hurt its policy room, even though its effectiveness remains disputed, according to Shin Kwan-ho, an economics professor at Korea University in Seoul.

With the country’s economic growth engine sputtering and exports falling for 10 months in a row through September, offering direct funds to companies and buying equities could be another option.

“Given the large size of the Korean stock market, equity purchases would also be another plausible avenue to get liquidity to firms,” said Lloyd Chan, an economist with Oxford Economics. “Corporate bond purchases might not be as effective, given that the corporate bond market is relatively smaller in size.”

Bubble Concern

Almost every economist warned against fueling a property bubble with household debt at a record level -- something the BOK had on its mind when it raised its interest rates to 1.75% from 1.5% in November last year.

Back in 2016, then-President Park Geun-hye’s party took a different approach to address the housing debt problem, asking the BOK to consider buying mortgage-backed securities and calling on it to look into buying state-bank bonds to facilitate corporate restructuring. While the economy expanded 2.9% that year, it’s forecast by economists to expand 1.9% this year -- the slowest pace since the global financial crisis.

“Similar conditions exist now, with high household debt and signs that consumer spending is losing momentum,” said Alex Holmes, an economist with Capital Economics. “Lower mortgage rates could encourage households to take on more debt, causing larger problems down the line.”

Korea May Be Forced to Use Unconventional Stimulus For Economy Hit by Trade War

In the near term, additional fiscal policy support may be more likely than unorthodox policies from the BOK. President Moon Jae-in said Monday that fiscal policy should play a “bold role more than ever,” after global finance ministers and central bankers gathered in Washington over the weekend to drive home the idea of combining government spending with monetary policy and structural reforms to generate growth.

“No one would pick a fight with the BOK for taking unconventional measures if the rate went to as low as 0.5%,” said Oh Suk-tae, an economist for SG Securities in Seoul, a unit of Societe Generale SA. “Central banks in advanced nations have blazed the trail, and the BOK will have no shortage of ideas. The question is, will it work?”

--With assistance from Tomoko Sato and Jaehyun Eom.

To contact the reporter on this story: Sam Kim in Seoul at skim609@bloomberg.net

To contact the editors responsible for this story: Malcolm Scott at mscott23@bloomberg.net, Paul Jackson

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