South Korea Cuts Rate to Record 2% as Economy Shrinks

By William Sim

Feb. 12 (Bloomberg) -- The Bank of Korea cut its benchmark interest rate to a record-low 2 percent to revive an economy headed for the first recession in more than a decade as exports and spending cool.

Governor Lee Seong Tae and his board pared the seven-day repurchase rate by a half point in Seoul today, the sixth reduction since early October. The decision was expected by six of nine economists surveyed by Bloomberg.

Finance Minister Yoon Jeung Hyun took office this week and pledged to step up stimulus spending after forecasting the economy will contract 2 percent this year and lose about 200,000 jobs. Central banks from Malaysia to Taiwan have lowered rates and Asia’s governments unveiled more than $685 billion in fiscal stimulus to revive their export-dependent economies.

“We definitely need more action as the economy is cooling much faster than expected,” said Chun Chong Woo, an economist at SC First Bank Korea Ltd. in Seoul. “It’s not time to stop cutting rates yet.”

The central bank has lowered borrowing costs by 3.25 percentage points since Oct. 9, the most aggressive easing undertaken since it began setting a policy rate a decade ago.

The Kospi stock index dropped 1 percent to 1,178.63 at 10:45 a.m. in Seoul, heading for its fourth straight decline. The won, Asia’s worst performer last year, shed 0.2 percent to 1,396.5 per dollar after touching a two-month low yesterday. The yield on the five-year government bond fell 1 basis point to 4.52 percent.

Recession Nears

Recession is looming in South Korea for the first time since the 1997-1998 Asian financial crisis as demand from China, Europe and the U.S. for exports of mobile phones, memory chips and cars dries up. The economy shrank 3.4 percent last quarter.

Woori Finance Holdings Co., owner of South Korea’s second- biggest bank, today posted its first quarterly loss in almost five years on increasing provisions for bad loans. Kookmin Bank, South Korea’s biggest, reported a quarterly loss yesterday.

“The board will do what is needed to improve liquidity conditions and to ward off the risk of a severe slowdown in economic activity,” the central bank said today.

The bank lowered the rate on special loans for smaller companies by 25 basis points to 1.25 percent.

Overseas shipments, which make up about 60 percent of gross domestic product, tumbled by a record 32.8 percent in January. Factory output plunged an unprecedented 18.6 percent in December, as exporters Hyundai Motor Co., Hynix Semiconductor Inc. and LG Display Co. cut output to cope with sagging demand.

Unemployment Rises

The number of South Koreans with jobs dropped by 103,000 in January, the biggest decline in more than five years, as retailers and manufacturers fired workers. Borrowing by household decreased for the first time in a year in January.

Yoon, the first South Korean minister to predict an economic contraction in 2009, said he’ll increase spending “as soon as possible” in addition to the 51 trillion won ($36 billion) in stimulus already allocated. The government will propose an extra budget to parliament by the end of March, he said on Feb. 10.

The government plans to set up a 20 trillion won fund to buy banks’ preferred stock and subordinated debt as the weakening economy increases bad loans and erodes lenders’ capital.

The central bank soon may need other ways to improve the flow of credit, said Seo Chul Soo, a fixed-income analyst at Daewoo Securities Co. in Seoul.

“The question now is what’s to come next after the BOK is done with rate cuts,” Seo said, adding the bank could consider buying government bonds directly to help stabilize the long-term debt market.

Global Rates

Central bankers around the world have slashed interest rates as economies including the U.S., Europe and Japan sink into recessions because of fallout from the global credit freeze.

Australia pared its benchmark rate to a 45-year low of 3.25 percent last week. Taiwan’s central bank cut its key rate last month to 1.5 percent after a record decline in exports.

As conventional monetary policy tools lose their potency, policy makers are seeking new ways to prop up flagging economies and revive their financial systems.

Bank of England Governor Mervyn King said yesterday the U.K. is in a “deep recession” that may force policy makers to create money and pump it into the economy after cutting interest rates to a record low of 1 percent. The Federal Reserve is considering buying long-term Treasuries after reducing the U.S. benchmark interest rate almost to zero.

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