🚨 Korean Economic Growth Forecast and Base Rate Cut

Today Korean Economic News | 2025.01.23

📌 "Korean Growth Rate to Stop at 1.6% This Year... Interest Rate Cut of 0.75%P Within the Year"

💬 Korea's economic growth rate for 2025 is forecast to stop at 1.6%, and it has been suggested that the base rate may be cut by a total of 0.75 percentage points within the year. It appears that economic stimulation will be sought through additional interest rate cuts from the current base rate of 3%.

1️⃣ Easy to Understand

Along with the forecast that the Korean economy will grow more slowly than expected, there is a prediction that the Bank of Korea will significantly lower interest rates. Let's explain this situation with an everyday example.

Think about a family budget. In a situation where household income is expected to increase less than anticipated, it's similar to lowering credit card interest rates to increase family spending and investment. The government and central bank manage the 'household ledger' of the entire economy, and since income (economic growth) is expected to be low, they are trying to encourage consumption and investment by lowering loan interest (base rate).

How will interest rate cuts affect our daily lives? The interest burden on mortgages or personal loans may decrease, increasing household spending capacity. For example, if someone has a 300 million won mortgage, when the interest rate drops by 0.75 percentage points, the annual interest burden decreases by about 2.25 million won. This has the effect of creating an additional disposable income of about 180,000 won per month.

But there are also disadvantages to interest rate cuts. Interest income from savings or deposits decreases, and asset prices such as real estate or stocks may rise, potentially creating relative disadvantages for those who do not own assets. Ultimately, an interest rate cut is like a 'medicine' for economic stimulation, but it is a policy tool that must also consider side effects.

2️⃣ Economic Terms

📕 Economic Growth Rate

Economic growth rate is an indicator showing how much a country's economic size has increased over a certain period.

• It is mainly measured by the growth rate of Gross Domestic Product (GDP) and is considered an important indicator of economic vitality and improvement in living standards.
• Developed countries often show growth rates of 2-3%, while emerging countries often show 4-6%, and Korea's potential growth rate is assessed to be around 2%.

📕 Base Rate

The base rate is the policy rate set by the central bank, which serves as the basis for market interest rates.

• It is the interest rate applied by the Bank of Korea when trading with financial institutions and affects various interest rates such as loan rates and deposit rates.
• It is a core policy tool for achieving various economic goals such as inflation control, economic stimulation, and financial stability.

📕 Monetary Policy

Monetary policy is the policy by which the central bank adjusts the money supply and interest rates to regulate the economy and prices.

• Interest rate increases (contractionary monetary policy) are mainly used for price stability, while interest rate cuts (expansionary monetary policy) are mainly used for economic stimulation.
• Since there is a lag of 6-12 months before policy effects appear, preemptive responses based on forecasts of future economic conditions are important.

📕 Economic Downturn

An economic downturn refers to a period when economic activity is generally contracted and growth slows.

• It is characterized by decreases in consumption, investment, employment, and deterioration in corporate performance, and in severe cases, can lead to a recession.
• According to business cycle theory, economic downturns inevitably occur, but their intensity and duration can be controlled with appropriate policy responses.

3️⃣ Principles and Economic Outlook

💡 Background and Meaning of Low Growth Forecast

• Several structural factors are at play in the background of Korea's economic growth rate being forecast at 1.6% for 2025.
  • First, the global economic slowdown is having a significant impact on Korea's export-oriented economy. Export growth is weakening due to the economic growth slowdown in China, a major trading partner, and the contraction of consumer sentiment in the United States and Europe.
  • Second, demographic structure change is also an important cause of growth rate slowdown. The decrease in the working-age population due to aging and low birth rates is a factor weakening long-term growth potential.
  • Third, household debt burden and real estate market instability are constraining domestic demand recovery. In particular, debt accumulated during the period of rising interest rates is acting as a factor limiting consumption and investment capacity.
  • Fourth, uncertainty due to global supply chain reorganization and increased geopolitical risks is also dampening corporate investment sentiment.
• The downward adjustment of the growth rate forecast in this context suggests that the economy's structural challenges are intensifying. However, a growth rate of 1.6% signifies a 'low growth' phase rather than a complete economic recession, and there is a view that this is a common phenomenon in the process of entering the developed country stage.

💡 Effects and Limitations of Interest Rate Cuts

• A base rate cut of 0.75 percentage points signifies an active monetary policy response for economic stimulation. The effects of interest rate cuts on the economy appear through various channels.
  • First, there is the effect of stimulating consumption and investment through reduced interest burdens for households and businesses. As interest costs for mortgages and business loans decrease, disposable income can increase and businesses' investment capacity can expand.
  • Second, there is the impact on asset prices. Interest rate cuts generally act as a factor increasing asset prices such as real estate and stocks, which can stimulate consumption through the wealth effect.
  • Third, there is the effect of strengthening export competitiveness through the exchange rate channel. The depreciation of the Korean won due to interest rate cuts becomes a factor enhancing the price competitiveness of export companies.
• However, there are also limitations and side effects of interest rate cuts. Above all, since there is a time lag until the effects of interest rate cuts are felt, the short-term economic stimulus effect may be limited. Also, excessive asset price increases may deepen asset inequality and stimulate household debt growth. Additionally, it must be recognized that with limited room for interest rate cuts, there is a limit to solving structural low growth problems with monetary policy alone.

💡 Macroeconomic Policy Direction and Challenges

• Macroeconomic policy to respond to the low growth era should pursue a balance between short-term economic stimulus and enhancement of medium to long-term growth potential.
  • From a monetary policy perspective, economic support through interest rate cuts is necessary, but balance with financial stability should also be considered. In particular, harmony with macroprudential policies for household debt management and maintaining asset market stability is important.
  • From a fiscal policy perspective, strategic investment for productivity improvement is needed along with domestic demand stimulation through expansionary fiscal operations. It is necessary to concentrate fiscal investment in areas that enhance growth potential, such as R&D support, human capital investment, digital transformation, and green growth promotion.
  • From a structural reform perspective, important tasks include enhancing labor market flexibility while strengthening social safety nets, enhancing corporate vitality through regulatory rationalization, and strengthening service industry competitiveness. Additionally, population policies to respond to low birth rates and aging, and win-win cooperation policies to bridge the gap between small/medium enterprises and large companies are also essential for sustainable growth.
• Policies should be designed to overcome the low growth trend and restore economic vitality through an organic combination of these various policy instruments.

4️⃣ In Conclusion

The forecast that the Korean economy will only grow by 1.6% in 2025 and the expectation of a 0.75 percentage point base rate cut within the year show the challenges our economy faces and the policy direction to address them. This low growth forecast is due to structural factors such as demographic changes, global economic environment changes, and industrial structure transformation, rather than short-term economic fluctuations, requiring a comprehensive response from a long-term perspective.

Base rate cuts are an important means to ease the interest burden on households and businesses and to promote domestic demand. However, since there are limitations to recovering growth momentum through monetary policy alone, fiscal policy and structural reforms must be pursued in parallel. In particular, efforts to increase the potential growth rate through productivity improvement, strengthening innovation capabilities, and human capital investment are essential.

A strategic approach suitable for the low growth and low interest rate era is also needed at the individual and corporate level. It is advisable for households to use the reduced interest burden following interest rate cuts for debt management and long-term asset allocation optimization rather than short-term consumption increases. For businesses, it's time to seek growth strategies through technological innovation and new market development beyond simple cost reduction.

Policy authorities should pursue a sophisticated policy mix that ensures the effects of interest rate cuts are evenly spread throughout the economy while minimizing side effects such as deepening asset inequality or increasing household debt. Also, there is a need to place more weight on structural reforms to secure a medium to long-term growth path rather than focusing on short-term economic responses.

Ultimately, the low growth era is both a crisis and an opportunity. It requires a transition to a new economic paradigm that pursues qualitative growth and inclusive development, moving away from the economic operation methods and mindsets of the past high-growth period. If this transition is successfully achieved, even with a lower growth rate, a more sustainable and balanced economic development can be realized.