South Korea Cuts Rate by Record as Markets Slump, Economy Flags

By William Sim and Seyoon Kim

Oct. 27 (Bloomberg) -- South Korea slashed interest rates by a record amount and pledged extra tax cuts and spending to tackle the nation's biggest crisis since it needed an International Monetary Fund bailout 10 years ago.

The Bank of Korea cut the benchmark rate by 75 basis points to 4.25 percent at an emergency board meeting in Seoul today, the second reduction in less than three weeks. Vice Minister Kim Dong Soo said the government will increase spending to bolster an economy that last quarter grew at the weakest pace since 2004.

The Kospi stock index rose 0.7 percent today, ending last week's 21 percent slump, the biggest decline in at least two decades. The central bank said today it will accept a wider range of bonds as collateral in money-market operations, intensifying efforts to boost liquidity in the banking system following the government's guarantee of lenders' debts last week.

``Concerns over a hard-landing of global growth have intensified dramatically,'' said Eva Yi, an economist at Goldman Sachs Group Inc. in Hong Kong. ``We expect the government to speed up the implementation of large-scale fiscal stimulus.''

The central bank today reduced the interest rate on special discount loans for smaller businesses to 2.5 percent from 3.25 percent, and also eased rules on foreign-currency lending to aid exporters.

South Korea banks and companies are struggling to service offshore debts as the deepening global credit crisis leads to a shortage of U.S. currency.

The government last week pledged to guarantee local bank borrowings up to $100 billion, which will cover the $72 billion of lenders' foreign-currency debt falling due by mid-2009.

`Brief Boost'

The Kospi index rose to 946.45 at the close of trading in Seoul, reducing this year's drop to 50 percent. By comparison, Japan's Nikkei 225 Average slumped 6.4 percent today, Hong Kong's Hang Seng index tumbled 8.8 percent and Taiwan's Taiex fell 4.7 percent.

``The rate cut might provide a brief boost to the financial market but the general panic environment prevails,'' said David Cohen, director of Asian economic forecasting at Action Economics in Singapore.

The three-year government bond yield slid 44 basis points, or 0.44 percentage point, to 4.52 percent. South Korea's won dropped 1.5 percent to 1,442.75 per dollar.

The won slumped 30 percent in the past three months, the biggest loss among Asia's 10 most-traded currencies outside of Japan, as investors dump emerging-market assets.

President Lee Myung Bak said today South Korea is far from experiencing a repeat of 1997, when the currency lost half its value and the government needed a $57 billion loan from the IMF to help companies repay debt.

Emergency Meeting

Lee held an emergency meeting yesterday with Finance Minster Kang Man Soo and central bank Governor Lee Seong Tae, following his return from a Beijing summit of Asian and European leaders at which they called for an overhaul of World War II-era banking rules.

Today's interest-rate cut ``was called for in order to guard securely against the possibility of a sharp contraction of real economic activity,'' the central bank said in a statement.

South Korea's economic growth slowed to 0.6 percent in the third quarter as exports declined by the most in almost seven years and consumer spending stagnated.

Bank of Korea Governor Lee hinted at further rate cuts, saying policy makers will ``pay more attention'' to the risk of slower economic growth. Inflation is likely to ease on weak domestic demand and falling oil prices, he said.

Further Action

``More aggressive cuts are on the way,'' said Lee Sang Jae, an economist at Hyundai Securities Co. in Seoul, who expects Korea's key rate will be slashed to around 3 percent by the first half of 2009. ``The government would need to expand tax cuts and increase fiscal spending to support the economy.'

South Korea last week said it will spend as much as 8 trillion won ($5.5 billion) helping the construction industry, including buying unsold homes and land. The central bank said Oct. 24 it will inject 2 trillion won into the financial system through repurchase-agreement operations.

South Korea's total external debt was $420 billion as of June, according to the finance ministry. Of that, $176 billion was short-term debt due to mature within a year.

To contact the reporter on this story: Seyoon Kim in Seoul at skim7@bloomberg.net; William Sim in Seoul at wsim2@bloomberg.net