South Korea's central bank last week lowered its policy interest rate by 0.25 percentage points to a record-low 1.5 percent just as Asia's fourth biggest economy faces a slowdown in both economic growth and price rises. The spread of Middle East Respiratory Syndrome (MERS) in the country threatens to dampen consumer spending. Given the difficult state of the economy, South Korean authorities need to flexibly mobilize fiscal and monetary policy tools.
A preliminary report shows that South Korea's gross domestic product in the January-March period registered a dismal increase of 0.8 percent in real terms from the previous quarter, marking growth of less than 1 percent for four consecutive quarters. The outbreak of MERS in late May has applied additional pressure on the central bank to reduce the policy rate. The MERS outbreak led some 67,000 foreign tourists to cancel their visits in the first nine days of this month. Department stores and supermarkets have also been hit by declining sales. In April, the Bank of Korea revised downward its 2015 growth estimate from 3.4 percent to 3.1 percent. But the spread of MERS may further lower this year's growth to a level between 2 percent and 3 percent. This would mean the lowest growth since 2012, when the economy grew only 2.3 percent.
A view is emerging that the South Korean economy is already in the grip of deflation. The consumer price index has been rising at less than 1 percent from a year before for six straight months, with the May figure registering a mere 0.5 percent increase. If the effect of the tobacco price hikes in January is excluded, the index has been in negative territory for four months in a row.