Korea policies put spotlight on growth

2015 budget spending will have bigger increase.

Korea’s policies continue to focus on growth, with the finance minister recently saying that the government will boost budget spending by 5.7% (KRW 20trn) in 2015, a bigger increase compared to 3.5% in the original plan.

According to a research note from DBS, more details about the FY2015 budget will be unveiled soon, before the proposal is submitted to the parliament for approval in end-September.

On monetary policy, the BOK held rates steady last Friday but retained a dovish tone in its policy statement.

Here’s more from DBS:

Whilst recognizing that exports are faring well and domestic demand has improved, the BOK also said that business and consumer sentiment has not yet recovered clearly.

Meanwhile, the governor disclosed that one member voted for further rate cut at Friday’s meeting.

In light of the dovish comments from the central bank, expectations about monetary easing have resurfaced in the financial markets. The 1Y IRS rate dropped 5bps last Friday.

The short-term government bond yields also slipped.

Adding to the rate-cut expectations was the sharp fall of the JPY in the last few days and renewed concerns about competitive currency devaluation.

Against such a backdrop, investors will need to see more positive news on the domestic data front before reassessing the probability of rate cuts (a turning point could be the release of 3Q GDP data in late-October).

Regarding the government's pledge of boosting growth via fiscal policy expansion, it should have greater implications for the medium-to-long term.

Under the original fiscal consolidation plan, the growth of budget spending will be capped at 3.5% (YoY) during the next three years and fiscal deficit will be reduced to 0.4% of GDP in 2017.

If the 5.7% budget increase is confirmed for 2015, the deficit ratio is estimated to deteriorate by 0.5ppt. This would require additional bond issuances next year and put upward pressures on the long-term KTB yields.