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[Editorial] Roadblocks ahead

A mix of negative economic factors demand policymakers take extra caution

By Korea Herald

Published : Sept. 25, 2023 - 05:30

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The South Korean economy is set to grapple with three volatile conditions -- the so-called “three highs” -- in the coming months: higher interest rates, high energy prices and the higher value of the US dollar against the Korean currency.

First and foremost, the US interest rate change is drawing keen attention from Korean policymakers and investors as its impact is potentially critical. The US Federal Reserve on Wednesday left interest rates unchanged, but signaled it may opt for one additional rate hike to combat inflation before the end of the year.

The Fed has raised rates 11 times in the past 18 months, leaving the benchmark borrowing cost between 5.25 and 5.5 percent. As Korea’s central bank held its key interest rate steady at 3.5 percent for the fifth straight time in August, the gap in the rates between the two nations remains the same at 2.0 percentage points.

If the Fed opts for another rate hike, it will widen the difference in interest rates between Korea and the US, a scenario that is feared to encourage capital flight from the local market, which in turn will undercut the already weakening value of the Korean currency.

Although the Korean officials in charge of economic policy downplay the possibility of capital flight, the greater gap in interest rates and its resultant impact on the overall economy continues to be one of the hotly debated issues here.

Second factor to consider is the stubbornly high energy prices, which continue to pose threats to both Korean exporters and consumers. Following the Fed’s decision last week, international oil prices slightly retreated but remained at a burdensome level.

Brent crude, the oil price benchmark, closed at $93.27 a barrel on Friday, down 0.3 percent in the week that marked the first downward change in three weeks. The lighter US crude, West Texas Intermediate, edged down at $90.03 a barrel, the first decline in four weeks.

But Brent crude shot up to a 10-month high two weeks ago of almost $94 a barrel, compared with $72 a barrel at its recent low in June. West Texas Intermediate also surged 34 percent during the same period.

Some experts predicted that oil prices might reach $100 a barrel as Russia and Saudi Arabia cut oil production and a demand from China rose. In early September, Saudi Arabia extended 1.3m barrels per day (bpd) of combined cuts to the end of the year, squeezing the global inventory level.

Russia not only cut supply to boost prices but also imposed a temporary ban on exports of gasoline and diesel, bringing fresh uncertainty into an already tight global energy supply.

Although the strength of the US dollar and the Fed’s rhetoric about higher interest rates put some downward pressure on oil prices last week, supply cuts led by Saudi Arabia are expected to prevent any steep downside moves.

Higher energy prices negatively affect Korea’s efforts to tame inflation and the bottom lines of major exporters, already hurt by slow demand for their products this year.

One worrisome signal for weak exports is reflected in the depreciation of the Korean won against the US dollar. The Korean currency ended at 1,336.8 won Friday. The value of the Korean won has stayed above the 1,300-won level since early August.

Furthermore, a mix of higher energy prices and the weaker local currency could translate to higher prices. The country’s consumer prices increased 3.4 percent in August from a year earlier, according to Statistics Korea. Producer prices expanded 0.9 percent last month, spurred by higher global oil prices, the Bank of Korea said Wednesday.

Given that the country recorded a trade deficit of $500 million in the first 20 days of September, hit largely by higher energy prices, policymakers are urged to proactively deal with the negative economic factors to help the economy weather the stronger headwinds ahead.