Bank of Korea sees 2020 GDP contract 1.3%; keeps base rate on hold

The Bank of Korea revised down its 2020 growth forecast for the South Korean economy to a negative 1.3% from the previous 0.2% contraction on August 27, leaving the base rate unchanged as widely expected.

The latest forecast signals Korea's economy will contract for the third time in its history, with exports and private consumption suffering the fallout of the coronavirus pandemic. Asia’s fourth-largest economy shrank by 1.6% in 1980, hit by the oil shock, and by 5.1% in 1998 in the wake of the Asian financial crisis.

 

South Korea has been introducing stricter second-stage measures for social distancing since mid-August in response to a resurgence in COVID-19 infections. Amid no signs of the pandemic slowing, there are lingering concerns about an introduction of tighter third-stage restrictions, which would lead to shutdowns of cinemas, coffee shops and performance and wedding halls, as well as a ban on gatherings of more than 10 people.

“If the stricter Level-3 restrictions are imposed in the Seoul metropolitan area for a month, it will cut our economic growth by 0.4% points,” said KB Securities economist Kim Doo-un. “In case the restrictions are introduced nationwide for a month, it will pull economic growth down further by 0.8% points and push this year’s economic growth to the level of a minus 2%.”

Despite the forecast revisions, the Bank of Korea kept the base rate unchanged at a record low of 0.5% for the third consecutive month. It slashed the interest rate by 50 basis points in March and another 25 basis points in May.

Bank of Korea Governor Lee Ju-yeol said on August 24 during a Q&A session of the parliament’s finance committee meeting that the central bank will maintain an accommodating monetary stance, given the weaker-than-expected economy. But he signaled no plan to use monetary policy to cool the residential property market.

Analysts see little room for the Bank of Korea to cut interest rates further until the first half of next year. Instead, they are keeping a close watch on bond buybacks by the central bank as part of monetary easing steps. As market talk of the need of a fourth supplementary budget and a second disaster relief fund is growing, so are expectations about an additional government bond issue.

Finance Minister Hong Nam-ki told the parliament’s finance committee meeting this week that a second disaster relief fund, if raised, needs to depend wholly on new treasury issues. New supply in government debt pushes interest rates higher, or cutting bond prices, offsetting the effects of the central bank’s rate cuts.

“Given dwindling exports and the economic slump caused by COVID-19, the Bank of Korea will likely maintain its accommodating monetary stance,” said HI Investment & Securities analyst Kim Sang-hoon. “It will not change the base rate until next year.”

Write to Ikhwan Kim at lovepen@hankyung.com