Since the US Federal Reserve signaled last week that it was close to raising its interest rates soon, economic policymakers in Seoul are on edge for the potential impact to Korea’s fragile economy and financial markets.

The heightened likelihood of the US tightening as early as next month complicates the job of the Bank of Korea, in particular, which already faces a tough balancing act between the desire to support growth and worries over rising household debt levels.

In a globally anticipated speech Friday at the US central bank’s annual summit in Jackson Hole, Wyoming, Fed Chair Janet Yellen gave what many saw as the strongest signal of a hike so far this year.

“I believe the case for an increase in the federal funds rate has strengthened in recent months,” she said.

Fed Vice Chair Stanley Fischer went even further to hint that a move could come in September and that there may be another hike before the end of the year.

As the remarks sparked worries in the emerging world for the possible redirection of global funds to safer shores, Korea’s Finance Ministry announced Saturday the initiation of talks with Japan to reopen a bilateral currency swap line, which should give Korea some buffers to a sharp liquidity crunch.

“If a US rate hike does happen in September, earlier than December as many had forecast, emerging markets could see increased financial volatility,” the Korea Center for International Finance said in a note released prior to Yellen’s remarks.

Korea saw foreign money flowing out of the country last year when the market fretted over the US rate hike. In December, the world’s largest economy ended years of the zero interest rate era by lifting the funds rate and signaled more hikes would follow.

In the run-up to and after the historic shift in US monetary policy stance, Korea witnessed a net outflow of global funds: From June to February this year, a total of $26.6 billion exited the country.

Experts say Korea will be able to withstand a repeat of that, as it has stocked up $371 billion in emergency foreign reserves and is currently running a $12.1 billion surplus in the current account. But it could have an adverse impact by turning up market volatility and thus putting a damper on the country’s fragile recovery, they warn.

“The prospect of policy tightening in the US sparks worries over increased costs, but also raises expectations for the US economy becoming stronger,” said Ma Ju-ok, an analyst at Hanhwa Securities in Seoul.

As a rate hike strengthens the value of its currency, it could lead to a situation of a strong dollar and a weak won, making Korean products more competitive, she said.

As for the monetary policy options, however, an increase in US borrowing costs could reduce the chances of BOK cutting its own because such a move would widen the interest rate gap between the two countries and fuel the feared capital outflow.

The BOK in June lowered its base rate to an all-time low of 1.25 percent. 

“The BOK will have to wait for the Fed decision and its impact on the global and local markets before it decides on its own course of action,” said Lee Chang-sun, senior researcher at LG Economic Research Institute.

The BOK next reviews its rate on Sept. 9, before the Fed decides. 

By Lee Sun-young/(milaya@heraldcorp.com)