[Exclusive] BOK Nominee Shin Says Stagflation Risk in South Korea Is Low

Shin Hyun-song, nominee for governor of the Bank of Korea, said the risk of stagflation in South Korea is low. But if the war in the Middle East drags on and fears of an economic downturn become reality, the government should respond with a coordinated framework that includes monetary and fiscal policy, he said.

In written answers submitted on April 8 to lawmaker Cha Kyu-geun of the National Assembly's Planning and Finance Committee, Shin wrote that "for now, the possibility of stagflation is not high." Concerns have been mounting that a surge in global oil prices following the conflict involving the US, Israel and Iran could bring on stagflation, with inflation rising even as growth slows.

Shin acknowledged that the Middle East war has increased upside pressure on prices and downside pressure on growth through higher energy costs and supply disruptions. Still, he said a strong semiconductor cycle and the government's supplementary budget should cushion part of the shock.

He described the recent pickup in inflation as the result of a temporary supply shock. While declining to comment on interest-rate decisions ahead of a monetary-policy meeting, Shin wrote that, in principle, it is not desirable to use monetary policy to respond to a temporary supply shock.

If the war persists and its effects on inflation and growth broaden significantly, no single policy would be enough, he said. Authorities would need to deploy monetary policy, fiscal policy and other measures together.

Shin also said South Korea's foreign-exchange reserves, which stood at $423.6 billion as of last month, are sufficient to buffer external shocks. The comment pushes back on calls to build reserves further to stabilize markets as the won trades around 1,500 per dollar.

He cited the country's large net external financial assets, low short-term external debt ratio and a current-account surplus that remains near record levels. Net external financial assets stood at $904.2 billion at the end of last year, equal to 48.3% of gross domestic product.

The ratio of short-term external debt to foreign-exchange reserves was 41.8% at the end of last year, Shin wrote, down sharply from 286.1% at the end of 1997 and 72.4% at the end of 2008.

He also rejected criticism that South Korea falls far short of reserve levels deemed adequate under metrics cited in relation to the Bank for International Settlements. There is no universally accepted global standard, he wrote, and neither the International Monetary Fund nor the BIS has presented a quantitative benchmark for South Korea's adequate reserve level.

Some academics have recently argued that the BIS approach calculates adequate reserves by adding three months of import payments, liquid external debt, 33% of foreign investment in domestic securities and residents' foreign-currency deposits. By that measure, South Korea's adequate reserve level would exceed $700 billion.

Shin said the BIS reserve metric often cited lately was only one method mentioned in a one-off report prepared for an international conference in February 2004. He added that the report itself said the calculation was not based on a specific theory, required further review and could prompt debate over the weights assigned to each indicator. Shin served as head of the BIS Monetary and Economic Department from 2014 through March.

He also said holding large foreign-exchange reserves carries substantial costs. Given low returns on reserve management and opportunity costs such as interest paid on Monetary Stabilization Bonds, there is little need to sharply expand reserves, he wrote.

Shin expressed concern about South Korea's household debt. Citing major domestic and international studies, he said the threshold at which household debt constrains consumption and economic growth is 80% to 85%. South Korea's household debt ratio, at 88.6% last year, remains at a level that weighs on growth.

He stressed that practical efforts to reduce household debt should continue. Changes to the housing-finance system are needed, including incentive structures that would encourage financial companies to reduce mortgage lending, he wrote. At the same time, household debt should be managed consistently under the principle that lending be based on borrowers' repayment capacity.

Simsungmi/Choi Hyung-chang, Korea Economic Daily reporters smshim@hankyung.com