News Analysis: S. Korea's non-traditional money printing for restructuring to be tested

Bank of Korea (BOK), South Korea's central bank, unexpectedly cut its benchmark interest rate on Thursday from 1.50 percent to a new record low of 1.25 percent, an uncharted territory in the bank's 66-year history.

The rate cut, the first in 12 months, came a day after the announcement to create 11 trillion-won (9.5 billion U.S. dollars) funds, mainly covered by the BOK, to help restructure shipping and shipbuilding industries that have been subject to the government-led corporate restructuring.

Denying any direct links between the unanimous monetary-policy decision and the restructuring funds, BOK Governor Lee Ju-yeol told a press conference that the rate cut had no relevance to the government's restructuring scheme at all.

Lee said seven policymakers, including himself, considered only possible negative effects on employment, consumption and investment, highlighting that the restructuring was not a direct target during the rate-setting meeting.

Despite Lee's denial, the restructuring funds, called capital expansion funds, had raised controversy over money-printing from the very beginning of the planning of such funds.

Ruling Saenuri Party proposed a type of restructuring funds, financed by the BOK, on its April parliamentary election campaigns. Later, President Park Geun-hye ordered reviews to adopt a "selective" quantitative easing (QE), or a money printing for corporate restructuring in specific industries.

Opposition lawmakers denounced the calls, citing possible side effects from reckless money printing that should have been preserved for potential financial turmoil. The BOK initially expressed opposition, calling for a public consensus before its direct purchase of equities and bonds.

The controversy came to a conclusion following the unexpected rate cut. Under the restructuring scheme, the central bank should have issued monetary stabilization bonds to absorb liquidity, which would be offered by the BOK to finance the restructuring funds.

Without liquidity absorption, the benchmark interest rate would be put under downward pressure. To make overnight call rates meet the policy rate, the BOK is usually required to control liquidity by buying or selling the monetary stabilization bond.

As the policy rate was cut further by 25 basis points, the BOK won't need to sell the monetary stabilization bonds, leaving increased liquidity in the market. It indicates a non-traditional, Korean-typed QE, or a money-printing for specific industries.

"The capital expansion funds that our government decided to create is equivalent to 'helicopter money' which central banks of major economies refrain from performing," Moon Hong-chul, a fixed-income analyst at Dongbu Securities said in a report on Wednesday.

Helicopter money is an idea made popular by American economist Milton Friedman in 1969 as a way of avoiding deflation and boosting output by providing central bank money directly to economic units. It was named like that to describe the money printing as a helicopter dropping notes from the sky.

The Korean-version QE is different from a traditionally-accepted QE, which is used when interest rates are close to zero and the economic recession continues. The BOK had predicted South Korea's economic growth for this year at 2.8 percent, and the bank claimed more room left for rate cuts.

"QEs in advanced economies like the United States, Europe and Japan adopt a way of purchasing bonds in the second market, but our country's capital expansion funds will provide liquidity through the direct purchase in the primary market. It actually means helicopter money," said Moon.

Under the 10 trillion-won ceiling, the BOK was expected to provide as much as 8 trillion won for state-run banks, which exposed massive loans to struggling shipping firms and shipbuilders, to meet their capital adequacy ratios required under the Bank for International Settlement (BIS) framework.

The restructuring funds will be indirectly funded in a way that the BOK lends money to the Industrial Bank of Korea (IBK), called a conduit bank, which will insert the BOK loans into the capital expansion funds, but it will actually equal to a direct purchase of bonds from state-run banks.

The BOK entering an uncharted territory in interest rates and adopting a non-traditional QE will be tested. For the time being, the central bank would be freed from criticisms that the bank should have taken pre-emptive measures to bolster the lackluster economy amid the restructuring going on.

As Governor Lee mentioned, more accommodative monetary policy could generate synergy effect if the government rushes more actively to introduce fiscal stimulus measures. Lee forecast downside risks to the economy would get bigger in the latter half of this year.

However, the prolongation of record-low rates could increase the already record-breaking household debts exponentially, becoming a starting point to forming a bubble in the housing market. It could also allow the so-called zombie companies to manage to subsist on low borrowing costs further though the firms have no competitiveness to survive and no ability to make profits.

The U.S. Federal Reserve was expected to delay its rate hike from the anticipated June to later in the second half, but the U.S. rate-setting direction turned upward. The Fed's rate hike in the near future could cause an abrupt foreign capital exodus out of the South Korean financial market. Endit