[Editorial] Uneven tightening

Interest rates are often described as the economy's thermostat. This time, they resemble something closer to an emergency generator.

The Bank of Korea's decision last week to raise its benchmark rate to 2.75 percent, its first increase in 3 1/2 years, is an attempt to contain inflation imported through oil prices, geopolitical conflict and a weakened currency.

That may be unavoidable. But it does not make the adjustment any less painful for an economy whose strongest numbers conceal some of its weakest foundations.

The case for higher rates is difficult to dispute. Consumer prices have exceeded 3 percent for two straight months, driven largely by surging energy costs after renewed turmoil in the Middle East disrupted supply chains.

The won has remained stubbornly weak, trading above 1,500 against the US dollar throughout much of the past month. With US interest rates still well above Korea's, allowing the gap to widen further would invite additional capital outflows, a weaker currency and even greater imported inflation.

Yet this inflation is unusual. Interest rates are necessary, but they cannot repair disrupted supply chains, lower oil prices or strengthen the won overnight. The central bank is attempting to contain inflation despite its principal causes lying well beyond its control.

The headline numbers flatter the broader economy. Exports have reached record levels, powered overwhelmingly by an extraordinary semiconductor boom. Beneath the impressive export figures, however, lies nearly 2,000 trillion won ($1.34 trillion) in household debt and growing financial strain among borrowers with little cushion against rising interest costs.

The burden falls first on small businesses. The BOK estimates that a single increase of 25 basis points will add roughly 1.8 trillion won in annual interest expenses for self-employed borrowers, with the largest burden falling on those already borrowing from multiple financial institutions. Worryingly, delinquency rates among the self-employed have climbed to their highest level in a decade.

Mortgage holders and households that borrowed heavily during years of cheap money also face steadily rising repayment costs. Many companies are equally vulnerable; nearly 40 percent are unable to generate enough operating profit to cover their interest expenses.

The greater problem lies in economic policy itself. While the central bank has begun withdrawing liquidity, the Lee Jae Myung administration is preparing an expansionary budget exceeding 800 trillion won for next year and has floated additional spending financed by stronger-than-expected semiconductor tax revenue.

Monetary policy is applying the brakes while fiscal policy appears ready to press the accelerator. This contradiction leaves both policies less effective. Broad fiscal expansion could sustain inflationary pressure, leaving the central bank little choice but to keep interest rates higher for longer. Public spending may support headline growth, but it also increases the burden on households and small businesses that face higher borrowing costs.

Fiscal policy should become more precise rather than more generous. Debt restructuring for distressed borrowers, stronger credit guarantees for viable small businesses and targeted measures to prevent localized financial distress would complement monetary tightening instead of undermining it.

Windfall semiconductor tax revenue would also be better used to strengthen public finances and support long-term structural reform than to finance another round of broad stimulus.

Higher interest rates mark the return of economic gravity after years of exceptionally cheap money. That adjustment cannot be avoided. But monetary policy cannot carry the entire burden while fiscal policy pulls in the opposite direction.

Korea's success in navigating the new tightening cycle will be judged not by another record month for semiconductor exports, but by whether tighter money restores price stability.

Failing to align fiscal and monetary policy will leave higher rates to erode the households and businesses least able to bear them.