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Based on timely analysis on topics related to current issues that are of importance to economics and finance, our Survey Paper puts forward the implications as well as policy alternatives.
- Interest Rate Reversals between Home and Abroad: Impact on Capital Outflows and Financing Costs of Foreign Capital, and Implications [23-24]
- Senior Research Fellow LEE, Seungho and others / Nov. 17, 2023
- This article delves into the recent interest rate reversal between Korea and the US, analyzing its characteristics and potential implications. It also explores the impact of this rate reversal on the possibility of capital outflows and the associated cost of financing foreign capital.
A historical analysis of capital outflows during periods of rate reversals since the 2000s reveals that such rate reversals have not led to significant capital outflows. Regression estimates indicate a minimal impact on bond fund flows, with some influence on stock investment funds. The observed phenomenon is more closely linked to external uncertainties arising from US rate hikes and a shift in risk preferences than to rate reversals between home and abroad. The result highlights that rate reversals have a limited impact on the outflows of domestic and foreign securities investment funds.
However, persistent rate reversals drive up the costs of financing foreign capital and foreign exchange hedging for foreign investments, which requires caution. When residents issue Korean Paper (foreign currency-denominated bonds in Korea), rising coupon rates of issuing bonds are leading to mounting interest payment burdens. It is also noteworthy that most domestic investment institutions pursue an FX hedging strategy when investing in foreign bonds, which contributes to increased FX hedging costs and diminished investment returns.
The implications drawn from this article are as follows. First, efforts should be put into reinforcing economic fundamentals and maintaining external soundness to safeguard the resilience of the Korean economy against prolonged rate reversals coupled with global external shocks. Second, economic agents are encouraged to establish effective systems and strategies for financing foreign capital to prepare for the rise in borrowing costs. To this end, it is also crucial to diversify foreign capital financing instruments and manage foreign currency liquidity. Lastly, domestic investors should develop systematic FX hedging policies that align with the characteristics of individual investment institutions or funds, rather than adopting routine FX hedging practices when investing in foreign securities.
- Current State and Risk Factors of Household Debt in Korea [23-23]
- Research Fellow Jung, Whayoung / Nov. 08, 2023
- The prolonged accumulation of household debt in Korea presents a considerable threat to the country’s economic stability. Korea’s household debt, characterized by its high level and rapid growth, requires careful management strategies to ensure stability. A close examination with a focus on individual households reveals a rising concentration of debt, particularly among households headed by those aged 44 and below.
Analyzing the impact of household leverage on consumption, this article finds that the growing debt servicing burden arising from leverage expansion hampers household consumption. Notably, households with excessive leverage experience a prominent slowdown in consumption, suggesting that future consumption growth could be limited despite income increases. Furthermore, as higher leverage magnifies household vulnerability, heavily leveraged households tend to hold smaller financial and net assets, rendering them more susceptible to economic shocks. The effects of monetary tightening become more pronounced, underscoring household vulnerabilities. If high interest rates persist over the long term, loan delinquency rates could rise among heavily indebted households, exacerbating financial distress.
Despite the macroeconomic challenges potentially posed by household debt, there remains a high risk of continuous surge in household debt, primarily driven by real estate-related loans. The prevalent trend of a significant preference for real estate investment among households raises concerns about the expansion of household debt fueled by expectations of rising property prices. In addition, the potential leverage expansion through interest-only lease loans, exempt from the Debt Service Ratio (DSR), poses an additional threat to future household debt management.
The increasing likelihood of a prolonged high-interest environment requires caution for the risk associated with the expansion of household debt. If the high-interest regime persists, the principal and interest repayment burden may rise rapidly, driven by high leverage levels. This may result in a more sluggish growth of consumption than expected, intensifying downside risks to the economy. Furthermore, an extended period of high interest rates may expose heavily indebted households to deteriorating financial conditions, increasing the risk of insolvency. Hence, it is necessary to implement stringent management measures for vulnerable borrowers and take proactive measures including reserve accumulation, aiming to prevent insolvencies within the household sector from spreading to financial institutions.
- Reduced Interest Rate Sensitivity in the US Economy and its Implications [23-22]
- Senior Research Fellow Kang, Hyunju and others / Oct. 31, 2023
- Amid a surge in interest rates from the second half of 2022, major forecasting institutions initially presented a grim outlook for the US economic growth rate for 2023. However, as the US economy showed a more resilient growth trend than expected, these growth forecasts have been gradually revised upward. Previous studies have highlighted that structural economic changes, including financial innovation, regulatory relaxation, improvements in the monetary policy response framework, and globalization have contributed to the insensitivity of the US economy to interest rate changes. On the other hand, this article draws attention to a significant weakening of the impact of interest rates among monetary policy transmission channels during the current rate hike.
In this context, this article examines factors behind the change in long-term US Treasury yields during the recent rate hike period (March 2022 to July 2023) and decomposes these factors into monetary policy forecasts and the term premium for long-term Treasury bond holdings. Unlike previous rate hike periods, the rise in Treasury yields is solely attributed to monetary policy expectations, while the term premium has remained almost unchanged. Utilizing a dynamic stochastic general equilibrium (DSGE) model, this article analyzes the cause of the unusually low level of term premiums. It has been estimated to decline by nearly 100 basis points as of the end of 2022, primarily driven by large-scale Treasury bond holdings resulting from the US Fed’s quantitative easing. It is also noteworthy that as the mortgage, which comprises two-thirds of US household debt, primarily involves long-term fixed rates, the debt service burden of US households has remained at pre-Covid 19 levels, despite a sharp increase in the benchmark rate. In addition, the expansion of the aging Baby Boom generation with lower debt exposure has contributed to weakening the interest rate path.
As the correlation between the US real economy and interest rates is reduced, the uncertainty in estimating the neutral real interest rate, a reference rate for monetary policy, has increased. Accordingly, this inevitably necessitates improvised monetary policies for an extended period and makes it challenging to determine the appropriate level of tightening, possibly heightening uncertainty regarding the future growth trajectory. It should also be noted that the long-term US Treasury bond yields are expected to be greatly swayed by the term premium, rather than expectations for monetary policy. If a steep rise in term premium, as observed in September 2023, triggers Treasury yields hikes, it could lead to simultaneous increases in Korean government bond yields and intensify exchange rate volatility.
- Analysis of High-Interest Debt in Listed Companies: Current State and Implications [23-21]
- Research Fellow Lee, Sang Ho / Oct. 30, 2023
- The recent surge in the US benchmark interest rate and an economic slowdown in China have instigated a sense of crisis in Korea’s capital market, heavily dependent on external factors. With sluggish exports in the first half of this year, companies are grappling with a sharp decline in operating performance, intensifying market uncertainties related to worsening profitability and concerns about a debt default. Given a possible structural shift in interest rate policies, it seems challenging to swiftly dispel market uncertainties.
Despite these concerns, however, the risk of a corporate debt default spreading to the financial system remains low. This article assesses liquidity and default risks based on the assumption of operating cash flow downturns and collateral value depreciation. The results indicate a moderate increase in default risk among listed companies within a relatively stable range. Overall, there is no major concern regarding the financial soundness in the corporate sector. However, it is urgently necessary to identify and respond to micro-level issues, particularly in vulnerable sectors such as utilities and construction.
Conversely, the persistence of slowed growth necessitates a more profound discussion. Korean companies, affected by major crises like the 1997 Asian financial crisis and the 2008 global financial crisis, have prioritized debt soundness. Although debt financing costs have been on the decline over the past decade, corporate financial structure policies have neither gone beyond securing soundness through debt reduction nor fully utilized debt to realize the opportunity for growth.
Amid soaring interest rates and expanding credit risk in the private sector, it is commendable that Korea’s corporate sector has the capability to navigate the impending crisis systematically. Even in the current situation, it is worth considering effective debt management strategies from a forward-looking perspective. Companies that maintained financial soundness and entered a growth phase have proactively reduced debt during the low interest rate phase. To harness debt effectively, they should comprehensively examine diverse internal and external factors for enhancing growth potential.