Policy Planning & Coordination Division,
Monetary Policy Department,
The Bank of Korea
Tel : 822-759-4464
Fax : 822-759-4485

Monetary Policy in 1999
(February 1, 1999)

* English translation based on the Korean original which was decided upon by the Monetary Policy Committee on February 1, 1999)

I. Economic and Financial Outlook

   1. Economic Forecasts for 1999

     During this year, the Korean economy is expected to regain its growth momentum after its sharp contraction last year. Despite slower growth in export volumes, real gross domestic product(GDP) is anticipated to register positive growth, supported by a gradual recovery of domestic final demand including both consumption and investment.

     The current account is expected to continue in surplus this year. The size of the surplus, however, is likely to shrink considerably from the 40 billion dollars in 1998. This forecast is based upon expectations of an increasing trend in imports while the value of exports remains close to last year's level, owing in part to sluggish economic growth in the U.S. and the EU.

     Consumer prices, at an annual average, are anticipated to rise significantly more slowly than the 7.5% of last year thanks to the stability of the exchange rate and international raw material prices.

     With regard to employment, there are generally some lags between economic recovery and an increase in employment. In addition, the expected rate of growth is not enough to absorb all the new entrants to the labor market and those laid off during the restructuring process. Therefore, unemployment appears likely to rise higher than the 6.8% of 1998.

  2. Foreign Exchange Market

     In the foreign exchange market, there remain uncertainties regarding the growth of the global economy and possible reoccurrence of turmoil in the international financial markets. Foreign exchange supply is expected to outstrip demand during the year, helped by the surplus on current transactions, the increased inflow of funds from foreign direct and portfolio investment encouraged by the upgrade of Korea's sovereign credit ratings, and the expansion of short-term trade credits.

     In particular, the amount of both foreign direct and portfolio investment in Korea may increase significantly following the upgrading of Korea's sovereign credit ratings and anticipations of a further rise in stock prices, helped by expectations of economic recovery. Such phenomena may act to hinder the smooth operation of monetary and interest rate policies; it may be difficult to coordinate interest rate and exchange rate policies under the full opening of the foreign exchange and capital markets.

  3. Financial Markets

    Bank Credit

     Demand for loans is not expected to be high mainly due to the lack of new facilities investment and the reduction of debt-equity ratios through corporate restructuring. The demand for funds by small and medium-sized enterprises(SMEs), however, should pick up, led especially by new start-ups and venture firms, following the economic recovery.

     As for the household sector, demand for consumer loans, such as credit card advances, will pick up, and demand for funds for the purchase of housing and other assets will also possibly increase as stock and real estate prices recover.

     On the supply side, the government's active involvement in bank recapitalization and the purchase of bad loans have made it much easier for banks to meet the BIS capital adequacy ratios. Thus the credit crunch is expected to ease steadily as the number of SMEs going insolvent declines significantly. Meanwhile, financial institutions have become much more alert to risk management, and prudential regulation standards have become stricter. They now worry more about the increased possibility of fresh non-performing assets arising during the restructuring of large corporations. Therefore, banks are not likely to readily abandon their present conservative lending policies for the time being.

    Bond Market

     Bond issuance, which had risen sharply last year, is expected to be on a smaller scale, with the issuance of corporate bonds(CBs) declining owing mainly to the imposition of ceilings on financial institutions' CB holdings.

     In the public sector, though, the government itself intends to expand the volume of its bond issues substantially in order to finance the budget deficit. In addition, government-guaranteed bonds, including Deposit Insurance Fund Bonds, will continue to be issued on a large scale in order to support financial sector restructuring.

     This year the net amount of government and government-guaranteed bonds coming to market will reach 25 trillion won, a huge surge from the total of 15 trillion won last year.

     On the demand side, deposits at investment trust companies, which are the major purchasers of bonds, are expected to be sluggish. Nevertheless, banks' capacity for purchasing bonds should be expanded by the lack of demand for bank loans and the steady increase in bank deposits.

     Therefore, no significant problems should emerge on the supply or demand side.

    Stock Market

     The volume of stock supply should increase by a large amount because of the rise in new rights issues by financial and corporate institutions in their attempts to improve their financial structure. It is estimated that the volume of new rights issues this year will be much larger, easily surpassing the record of 13.5 trillion won set during 1998.

     Corporate profitability has been improved through the considerable reduction in financial expenses burden brought about by lower interest rates. The equity market should thus be buoyant, helped by the strengthening economic recovery and an inflow of foreign portfolio investment funds. This inflow may well prove sustained with the upgrade of Korea's sovereign credit ratings and generally optimistic expectations concerning the Korean economy. Therefore, corporations' attempts to raise funds by issuing such a large volume of new equity should not pose any problems.

     Some part of the funds currently invested in high yield products, such as banks' new installment-type money-in-trust and investment trust companies' bond-funds beneficiary certificates, may well flow into the stock market upon maturity. The establishment of more mutual funds should also help expand the demand for stocks.

     However, uncertainties remain concerning the Korean stock market. For one thing, the structural fragility of the Korean economy have not yet been completely overcome, and for another, the international economy may be shaken by unforeseen factors such as a possible devaluation of the Chinese yuan and panics similar to the Brazilian crisis.

II. Inflation Target

     After consultation with the government, the inflation target for 1999 has been set at 3กพ1%, based on the annual rate of increase in CPI. However, this excludes some extraordinary factors influencing prices, such as weather abnormalities causing wide swings in agricultural product prices, and tax-related legislative amendments which may result in price hikes.

     The consumer price inflation rate this year is projected to be around 3.0% on an annual average basis, which is much lower than last year's.

     The stability of interest rates, the exchange rate, international raw materials prices, and wages will play a significant role in keeping prices down. However, considering the downward stickiness of prices and the persistence of inflation, it is difficult to envisage a full adjustments in prices corresponding to the fall on the cost side.

III. Monetary Policy in 1999

     This year the Bank of Korea will conduct monetary policy with the focus on supporting the recovery of the real sector, insofar as this does not conflict with achieving the inflation target.

  1. Monetary Aggregates

     This year the expansionary pressure for money supply through the government and foreign sectors is anticipated to increase owing to a slower deceleration of the income velocity of money, the bunching of fiscal disbursements early in the year, and swelling inflows of foreign capital. This will make the operation of monetary policy more challenging.

     Therefore, the Bank of Korea will maintain liquidity at an appropriate level to prevent and even preempt inflation in the medium and long run. In the short run, however, market liquidity will be maintained flexibly in line with the business cycle and conditions in the domestic and international financial markets.

     To this end, the target range for the annual M3 growth rate is set at 13 to 14%, based on the inflation target(3กพ1%) and the forecasts of economic growth and income velocity of money for this year.

     With GDP growth turning positive again following last year's negative growth, the deceleration rate of the income velocity of M3 should slow significantly compared to that of last year(-12%).

Trend of M3 Growth Rate1)


1995199619971998 e1999 target2)
Notes: 1) On a December daily-average basis.
  2) On an annual daily-average basis.

     On a quarterly basis, the M3 growth rate will be managed flexibly within the annual target range. During the first quarter, it will be held close to 13 to 14%.

   2. Interest Rates

     In 1999, domestic interest rates are expected to keep their downward stability by and large, as supply will continue to outweigh demand in the foreign exchange market and the pace of the economic recovery is anticipated to be only modest.

     Therefore, in order to support the recovery of the real economy and to promote stability in the foreign exchange market, the Bank of Korea, for the time being, will maintain its policy stance of favoring lower market interest rates, including call rates, and pursue this through its open market operations.

     However, should the appreciation pressures on the Korean won rise because of a continued excess supply of foreign exchange in the market, such upward pressure will need to be eased by employing indirect methods to manage the interplay of supply and demand forces in the foreign exchange market by, for example, urging the early redemption of firms' foreign debts. Such actions should promote the well-coordinated operation of interest rate and exchange rate policies. In line with this, the Bank of Korea will carefully monitor the asset market to preempt the creation of any possible bubbles which might hinder the restructuring process.

     With slower deceleration in the velocity of money and the expansion of money supply through the government and foreign sectors expected, it is essential to maximize the role of interest rates in balancing the supply and demand for funds in order to maintain an appropriate level of money supply. However, large abrupt shifts in interest rates following temporary changes in the supply and demand for funds will be avoided.

   3. Improvement of Monetary Policy Paradigm

     The Bank of Korea will continue to strive to refine its monetary policy tool kit to equip it for the shifts in the financial and economic operational paradigms following the cessation of the IMF program. Included in these efforts are the easing of the rigidity in the supply structure of reserve money, the selection of a benchmark interest rate and analysis of the transmission effects of interest rates, and the development of various indicators to determine appropriate liquidity and interest rate levels.

     The Bank of Korea will also attempt to establish closer linkages between money, interest rates, and the exchange rate in response to the ever more intensive impact of financial market opening.

     In addition, research and analysis will be strengthened to prepare for a smooth transition from its current monetary targeting to inflation targeting.