The Korea Institute of Finance has cut its growth forecast for the Korean economy this year to 2.8 percent, a sharp drop from the previous 3.7 percent. It is the first time that a major local think tank has put the estimated growth rate below 3 percent.
This illustrates how bad the economic situation is: Exports declined for five straight months, with the continued depreciation of the Japanese yen and the slow recovery of global trade casting dark clouds for the coming months as well. Industrial output contracted for the second consecutive month in April.
On top of this came the Middle East respiratory syndrome outbreak, which is heavily denting the already ailing economy. The viral disease is directly hitting domestic consumption as people refrain from going outside.
Most severely hit are the retail, leisure and tourism sectors. Retail outlets like department stores and discount outlets are reporting drastic falls in sales and foreign visitors, especially Chinese tourists who buttressed the local travel industry, are shunning the country.
Given this situation, the prediction by a recent research report that the growth rate for the Korean economy will fall by 1.3 percentage points if the MERS scare persists for three months does not seem out of line.
So the Bank of Korea’s decision last week to cut the basic interest rate by a quarter percentage point to an all-time low of 1.5 percent was well accepted. The central bank made it clear that it made the decision as a preemptive action aimed at easing the negative effects of MERS on economic sentiment and the real economy.
The rate cut ― most analysts predicted that the central bank would freeze the rate in consideration of the anticipated rate increase in the U.S. and the growth of household debt here ― showed that the central bank is indeed worried about the short-term impact of MERS on the economy.
The problem is that the Korean economy suffers from too many ailments to be cured by an interest rate cut alone. The effects of the latest rate cut cannot be maximized without a complementary fiscal policy initiative, that being a supplementary budget to increase government spending.
Expanding government spending certainly runs the risk of increasing the fiscal deficit, but officials would be able to work out measures to minimize the negative effect on the government balance sheet, like expediting sales of government assets and state-controlled enterprises.
What’s obvious is the Korean economy, hit by an unexpected shock on top of chronic illnesses, needs intensive short-term treatment and therapy at the least.
