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

Shin Hyun-song, nominee to lead the Bank of Korea, said the risk of stagflation in South Korea is low. He added that if a prolonged war in the Middle East turns fears of an economic slowdown into reality, the government should respond with a coordinated framework including monetary and fiscal policy.

In a written reply submitted on July 8 to Rep. Cha Kyoo-geun of the National Assembly’s Strategy and Finance Committee, Shin said “the possibility of stagflation does not appear high at present.” Concerns have grown that surging oil prices driven by the recent conflict involving the US, Israel and Iran could trigger stagflation, a combination of inflation and economic weakness.

Shin acknowledged that the war in the Middle East has increased upside pressure on prices and downside pressure on growth through higher energy costs and supply disruptions. Still, he wrote that a strong semiconductor cycle and the government’s supplementary budget would help cushion some of the shock.

He described the recent rise in prices as the result of a temporary supply shock. While declining to comment on interest-rate decisions ahead of a monetary policy meeting, Shin said in principle it is not desirable to respond to a temporary supply shock with monetary policy.

If the war drags on and its effect on prices and growth widens significantly, a single policy tool would not be enough, he wrote. Authorities should respond by using multiple measures together, including monetary and fiscal policy. The remarks indicate that if the central bank faces a dilemma in which raising rates to curb inflation hurts growth while cutting rates to support the economy stokes prices, the government should mobilize all available tools, including fiscal policy and macroprudential regulation.

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 comments pushed back against calls to build reserves further to stabilize markets as the won trades around 1,500 per dollar.

To support that view, Shin cited South Korea’s large net external financial assets, low short-term external debt ratio and continued current-account surpluses. Net external financial assets stood at $904.2 billion at the end of last year, equal to 48.3% of gross domestic product. In effect, the country holds far more overseas assets than it owes abroad, leaving it with ample resources to stabilize the foreign-exchange market in an emergency.

The ratio of short-term external debt to foreign-exchange reserves stood at 41.8% at the end of last year, Shin said. That was far below 286.1% at the end of 1997 and 72.4% at the end of 2008.

He also rejected criticism that South Korea’s reserves fall well short of adequacy benchmarks cited by the Bank for International Settlements. There is no universally accepted global standard, Shin wrote, adding that neither the International Monetary Fund nor the BIS provides a quantitative estimate of an appropriate level of reserves for South Korea.

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 investors’ securities holdings and residents’ foreign-currency deposits. By that measure, South Korea’s adequate reserves would be well above $700 billion.

Shin said the BIS reserve metric often cited recently is only one method mentioned in a one-off report prepared for an international conference in February 2004. That report itself stated that the method was not based on a specific theory and that the indicators required further review, while the weighting of those indicators could also be debated. Shin served as head of the BIS Monetary and Economic Department from 2014 through March this year.

He also noted the costs of holding large foreign-exchange reserves. Given the low returns on reserve management and the interest expense from issuing monetary stabilization bonds, there is little need to sharply expand reserves, he wrote.

Shin expressed concern about South Korea’s household debt. He said major domestic and international studies put the threshold at which household debt constrains consumption and economic growth at about 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 concrete efforts to reduce household debt should continue. Institutional changes tied to housing finance are needed, including incentive systems that encourage financial companies to curb mortgage lending. He added that household debt should be managed consistently under the principle of lending based on borrowers’ repayment capacity.

Shim Sung-mi / Choi Hyung-chang, Korea Economic Daily reporters smshim@hankyung.com