Bank of Korea (BoK) policy makers and regulators have expressed concern about potential financial instability and capital outflows on the news of Fed rate-hiking.
The concerns about narrowing spread between US and Korean interest rates were apparently raised by r the officials of BoK in monthly meetings since October 2014, due to which Korean markets have been less attractive to investors. While the BoK has adopted a dovish stance in recent months, some MPC members see the need to maintain a certain spread between US and Korean interest rates in order to avoid disruptive capital outflows. Korea now has less trade exposure to the US via China, as well as directly. China's exports to the US are important for Korea's economy since Korea exports intermediate goods to China.
According to Standard Chartered, "The contribution of China's exports going to the US fell to 17% of the total in 2015 from 21.5% in 1999. The US' contribution to Korea's total trade reduced to 12.2% in early 2015 from 20.5% in 1999. While China's share rose to 25.4% from 9.5% over the same period. As a result, the US recovery is likely to provide a more limited boost to Korea's economy this year."
The KRW appreciation historically associated with Fed rate hikes, along with Korea's large current account surplus, is likely to counter any capital outflows. Hence, the Imperial bank of Korea does not need to be too concerned about the impact of Fed rate hikes in 2015 and can maintain its dovish stance, which is justified by still-soft growth momentum. However, Korea's declining trade links with the US in recent years suggest that Fed rate hikes may provide less of a boost now than in previous cycles.
