No escaping the power of interest rates

Cho Min-geun

The author is an editorial writer at the JoongAng Ilbo. 

It is unusual for Bank of Korea Gov. Shin Hyun-song to openly criticize fiscal policy. The central bank generally avoids commenting directly on government policies or politics, partly to protect its monetary policy independence from political interference.

Until August, Shin had deflected reporters' questions with a conventional response: Fiscal expansion need not conflict with monetary policy if it raises potential economic growth.

But at last week's press conference, his tone changed. While repeating that qualification, he stressed the need to consider fiscal sustainability. Once temporary revenue sources finance permanent spending commitments, he warned, reversing them becomes difficult. Ultimately, he said, the National Assembly must scrutinize spending rigorously.

Perhaps Shin has grown more confident six months into his tenure. More likely, he recognizes that economic conditions have become too difficult to accommodate complacency.

His overall message, delivered alongside what markets interpreted as a hawkish decision to hold interest rates, was straightforward: Difficult times lie ahead, so fasten your seat belts.

This assessment extends beyond the central bank. Many economists believe the four-decade era of structurally low interest rates, dating from the mid-1980s, is ending.

Globalization, which helped sustain cheap borrowing, is retreating. Restoring global supply chains looks increasingly difficult. Major economies face deteriorating public finances, while competition for investment in AI is driving up demand for capital and borrowing costs.

Cheap money once provided a cushion. Businesses and governments could survive occasional mistakes and inefficiencies. Without that protection, even minor missteps can produce severe consequences. France's fiscal difficulties offer a warning.

Individuals, companies and governments must therefore adapt their strategies to a fundamentally different financial environment. That is why Shin's warning matters.

Yet the Korean government remains trapped in habits formed during the low-interest-rate era.

Consider its proposed 162 trillion won ($114 billion) Future Response Fund. The original concept was reasonable: Set aside abundant tax revenue rather than immediately spending it, then invest the reserves in future growth.

But the operating plan prepared by the Ministry of Planning and Budget raises troubling questions.

Its 45 trillion won investment allocation includes projects that could easily be financed through ordinary budgets, alongside cash assistance programs such as basic income for rural communities.

Meanwhile, the proposed annual return on 104 trillion won in surplus funds is just 3.85 percent, below the 4.1 percent yield on 10-year government bonds.

Officials at the Ministry of Finance and Economy understandably questioned whether using more money to repay government debt would make greater sense.

Yet documents disclosed by People Power Party Rep. Park Soo-young indicate that these fiscal watchdogs' objections were entirely disregarded during interministerial consultations.

The government appears increasingly dominated by advocates of aggressive fiscal expansion and optimistic economic assumptions.

A semiconductor-driven surge in tax revenue probably explains much of this confidence. Korea's second quarter current account surplus exceeded the combined surpluses of Germany and Japan.

Encouraged by the economic boom, President Lee Jae Myung recently wrote on social media, "A rising tide lifts all boats."

Certainly, the semiconductor boom deserves celebration, and distributing its benefits fairly is important.

But financial markets have another saying: Nothing can defy interest rates.

Just as gravity governs physical objects, interest rates exert a powerful influence over asset prices. No investment boom can remain detached from financing costs indefinitely.

With global interest rates remaining elevated, Wall Street has already begun questioning whether today's massive investments in AI infrastructure are sustainable.

Semiconductor stocks have consequently struggled, demonstrating that even industries benefiting from extraordinary demand remain vulnerable to changing financial conditions.

The danger is assuming that today's exceptional revenues will continue indefinitely while treating temporary windfalls as justification for permanent expenditure.

When borrowing costs rise, fiscal commitments become harder to finance, investment returns face greater scrutiny and mistakes become more expensive.

High tides inevitably recede, just as the full moon eventually wanes. Economic prosperity follows cycles too.

Rather than becoming intoxicated by optimism and abandoning caution, policymakers should prepare for the future that higher interest rates are already bringing.

In this environment, prudent management of public finances is not an obstacle to growth. It is a necessary safeguard against the risks that accompany prosperity.

The government should heed the central bank's warning before today's temporary windfall becomes tomorrow's lasting fiscal burden.