It Begins Hitting Mid-Sized Firms First
Rising international oil prices and inflation concerns fueled by the conflict in the Middle East are once again stoking fears of interest rate hikes.
Rising international oil prices and inflation concerns fueled by the conflict in the Middle East are once again stoking fears of interest rate hikes.
Although the Bank of Korea’s benchmark interest rate remains frozen at 2.50 percent per annum, the yield on South Korea’s 10-year government bonds climbed to as high as 4.217 percent on May 15. Government bond yields serve as the benchmark for long-term government funding costs as well as borrowing rates for corporate capital procurement, including corporate bonds and bank debentures. For mid-sized and small companies with relatively lower credit ratings, borrowing costs rise because they must secure financing at rates that include additional risk premiums on top of government bond yields.
According to the financial industry on May 18, the ratio of substandard or below loans in total won-denominated lending at South Korea’s five major banks stood at 0.42 percent at the end of April, up 0.04 percentage point from the end of March. By borrower category, the ratio for small and medium-sized enterprises reached 0.63 percent, more than double the 0.31 percent recorded for large corporations. Compared with a month earlier, the ratio for small and medium-sized enterprises rose by 0.09 percentage point, whereas the ratio for large conglomerates fell by 0.04 percentage point.
As for delinquency rates, the overall delinquency ratio for banks’ won-denominated loans stood at 0.44 percent at the end of April, up 0.03 percentage point from the end of March. Among them, the delinquency rate for small and medium-sized enterprises climbed 0.07 percentage point from the previous month to 0.65 percent. In contrast, the delinquency rate for large corporations dropped 0.03 percentage point to 0.08 percent. Consequently, the delinquency rate for small and medium-sized enterprises has widened to roughly eight times that of large conglomerates.
According to broader banking sector data compiled by the Financial Supervisory Service, the delinquency ratio for won-denominated loans at all domestic commercial banks stood at 0.62 percent at the end of February, up 0.06 percentage point from the previous month. The delinquency rate for overall corporate loans was 0.76 percent, while the ratio for small and medium-sized enterprise loans climbed to 0.92 percent. Specifically, the delinquency rate for small corporate borrowers reached 1.02 percent, while the ratio for sole proprietors stood at 0.78 percent. The Financial Supervisory Service said, “Delinquency rates continue to rise mainly among small corporations, and preparations are needed for the possibility of further increases stemming from domestic and external uncertainties.”
From a corporate standpoint, a 1 percentage point increase in borrowing rates from 4 percent to 5 percent creates a substantial financial burden. For a company with 100 billion won, equivalent to about $66.44 million, in outstanding debt, annual interest expenses would rise by 1 billion won to 5 billion won from 4 billion won. Small and medium-sized manufacturing companies with low operating margins, as well as small firms in wholesale, retail, lodging, food service and construction-related sectors that rely on rapid working capital turnover, have difficulty immediately passing higher interest costs on to consumers. If raw material costs, labor expenses and financing costs all rise simultaneously while sales remain stagnant, profits decline rapidly and structural delinquency risks increase.
The rise in government bond yields in major overseas economies is also becoming increasingly concerning. Japan’s 10-year government bond yield briefly surpassed 2.7 percent on May 15, reaching its highest level in 29 years. The increase was driven by concerns over inflation, expectations of additional interest rate hikes by the Bank of Japan and growing fiscal spending burdens. In the United States, the 10-year Treasury yield climbed above 4.5 percent while the 30-year Treasury yield exceeded 5 percent, intensifying upward pressure on global bond yields. When long-term interest rates in major economies rise, South Korea’s bond market tends to move in tandem, pushing up yields on government bonds, bank debentures and corporate bonds alike. For South Korean small and medium-sized enterprises, this structure increases the likelihood of bearing higher borrowing costs due to the rising procurement costs of commercial banks.
The bigger concern lies ahead. The possibility of interest rate hikes is now being openly discussed. Ryoo Sang-dai, senior deputy governor of the Bank of Korea, said during a press conference held in Samarkand, Uzbekistan, on May 3 that “the time has come to consider stopping rate cuts and even raising rates.” When asked whether signals suggesting the possibility of a rate hike could emerge at the Monetary Policy Board meeting scheduled for May 28, he replied that “the possibility remains open.”
The Bank of Korea’s benchmark interest rate has remained unchanged at 2.50 percent per annum since it was lowered on May 29 last year. Until recently, market attention had focused on the timing of a further rate cut, but the combination of the Middle East conflict, high oil prices, and rising inflation appears to be shifting the weight of monetary policy back toward defending against inflation. Even if the benchmark interest rate is not officially raised, if the market prices in the likelihood of a hike in advance, yields on government bonds, bank debentures, and corporate bonds could all rise simultaneously.
The biggest issue is the accelerating pace of inflation. South Korea’s consumer price index rose 2.6 percent in April from a year earlier, up 0.4 percentage point from the 2.2 percent increase recorded in March. In particular, petroleum prices surged 21.9 percent from a year earlier. The rise in oil prices caused by the Middle East conflict is now beginning to feed fully into domestic inflation. According to the Bank of Korea’s April export and import price index data, import prices rose 20.2 percent from a year earlier. The monthly average price of Dubai crude stood at $105.70 per barrel in April, remaining above the $100 level.
State-run research institutes have also warned about the inflationary impact of high oil prices. The Korea Development Institute recently analyzed the effect of rising global oil prices on consumer inflation, saying that “oil price increases stemming from uncertainty in energy transportation could raise this year’s consumer inflation rate by 1.0 percentage point to 1.6 percentage point.” The institute added that “South Korea depends on the Middle East for about 70 percent of its crude oil imports, making it relatively more vulnerable to the impact of the Middle East conflict and potential disruptions in transportation through the Strait of Hormuz.”
Jung Suk-yee
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