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[Economy in Pandemic] Coronavirus puts Korean economy into uncharted territory

Calling COVID-19 pandemic impact ‘unprecedented,’ economists warn of potential credit crisis, urge authorities to find more room to intervene

March 17, 2020 - 16:24 By Son Ji-hyoung
From left: DBS Economist Ma Tieying, Pantheon Macroeconomics Senior Asia Economist Miguel Chanco and Economist Intelligence Unit Asia Analyst Waqas Adenwala
The Korea Herald is publishing a series of interviews and analysis over looming threats of COVID-19 on the Korean economy and beyond. This is the first installment. -- Ed.

Despite a series of emergency actions being taken by governments around the world, the novel coronavirus -- and its resulting disease COVID-19 -- is wielding sweeping power over the global financial market and the real economy, indicating rising global recession risks.

The Bank of Korea cut its policy rate Monday to a record low. The Finance Ministry proposed an extra budget bill of 11.7 trillion won ($9.4 billion), but is widely expected to execute more fiscal measures amid growing demand from political circles to take more aggressive action.

Economists watching Korea, however, began to quash hopes of economies in Asia staging a swift V-shaped recovery, saying the novel coronavirus might be the biggest economic threat yet in contemporary days.

“Certainly, I can’t recall an example in modern times where governments have acted this aggressively to contain the spread of a disease,” Miguel Chanco, senior Asia economist at Pantheon Macroeconomics, told The Korea Herald.

“In that sense, we’re setting history at the moment.”

As uncertainties and threats are lurking, Korea’s top decision-makers should brace for what is next to come, such as a potential credit crisis, experts added.

“The next big worry is whether the financial market correction will push up corporate debt spreads and default risks, causing a negative feedback loop between the financial and real economic sectors,” said Ma Tieying, economist at Singapore-based DBS.

Another powder keg, real economy-wise, could be a demand crunch to a further degree, which could be triggered by a drastic surge in infections across the globe due to insufficient testing means.

“The real challenge lies in addressing the crisis in developing countries,” said Waqas Adenwala, Asia analyst at the Economist Intelligence Unit. “The population density can be fairly high in a lot of Asian and African cities in developing countries but even resources to test for coronavirus remain scant which complicates the situation further.”

“The COVID-19 developments in the United States in particular are likely to get a lot worse before it gets better, as the lack of sufficient testing means that infections probably are significantly under-reported,” Chanco said.

In light of the situation rife with uncertainties, experts called on Korea to act out in a more aggressive fashion both in terms of monetary and fiscal policy, citing more room to engage.

“Following the 50 basis point rate cut delivered on Monday, we expect another 25 basis point cut from the BOK in the second quarter,” Ma said, citing the central bank’s latest decision that she said is expected to support demand-side activities and ease stress in the financial markets.

As for the Monday rate cut, experts were mixed on whether the Bank of Korea’s monetary easing decision was belated.

“The Bank arguably wasted away space to cut rates last year, when it flinched in the wake of Japan’s initial trade salvo, which in the end had minimal noticeable effect in macro terms,” Chanco said.

Ma, on the other hand, said the BOK’s actions have come at a fairly moderate pace, as it otherwise could have triggered distortions in asset prices, capital flight and exchange rate volatility.

“It is understandable that the BOK adopts a cautious stance on monetary easing, as its benchmark rate is already at historical low and not far from the zero bound,” Ma said. “Cutting rates too fast and too early could fuel the speculations about unconventional easing like negative interest rates and quantitative easing.”

Experts were also mixed on a second-quarter rebound in South Korea.

The question is whether the contraction in global demand could be offset by the world’s stringent containment measures.

“A ‘V’-shaped growth rebound in the second quarter (for Korea) has become unlikely,” Ma said. “It will take time for the number of infections to peak in other major areas like Europe and the US. Problems outside of China could continue to keep a lid on global economic activities in the second quarter.”

Meanwhile, Adenwala downplayed the possibilities of a recession at the current setting.

“Given the measures taken by policy makers all over the world, we estimate that the slowdown in the first half will not translate to a recession,” Adenwala said. “Even for Korea, we expect the economy to contract in the first quarter but the recovery in the subsequent period will help the country.”

When it comes to the government’s fiscal stimulus, experts agreed that it is capable of a large-scale bailout, citing comparatively low indebtedness of the Korean government by the international standard.

“I wouldn’t be surprised if the current COVID-19 budget being considered is followed by another supplementary budget later this year. It’s a relatively small package considering the likely huge short-term hit to the economy,” Chanco said.

Meanwhile, all three economists cast doubt on a state-led basic income plan -- in which money would be given directly to every citizen -- coming a month ahead of the general election.

“Introducing a basic income may help to cushion the blow. But it’s a slipper (slippery) slope and must be done carefully. It has to be time-limited and water tight to prevent it becoming a long-run fiscal burden,” Chanco said.

“Basic income scheme will be very challenging given South Korea’s political backdrop. Also, a simple cash transfer is unlikely to be the most effective method of supporting the economy,” said Adenwala.

By Son Ji-hyoung (