South Korea cuts rates record amount to tackle crisis

- South Korea on Monday delivered its largest ever interest rate cut and pledged more spending and tax cuts next year to help economic growth, already at a four-year low and likely to be hit further by the global financial storm.
But the 75 basis point rate cut to 4.25 percent failed to lift share prices after they dropped their most on record last week on growing fears that the economy, along with company profits, will buckle under the strain of the downturn across world markets.

"What investors really want isn't just a rate cut but measures to cure a liquidity squeeze," said Kim Joong-hyun, an analyst at Goodmorning Shinhan Securities. "It is the nervousness in the market that keeps credit tight."

South Korea's banks have looked particularly exposed to the global credit crunch, finding it difficult to roll over foreign currency loans, many of which are linked to forward covering of major export deals by local firms.

This lack of liquidity makes the banks in turn reluctant to lend at home, threatening domestic firms with their own credit crunch. This combination prompted the central bank's rate cut.

The Monetary Policy Committee slashed the base rate by 75 basis points to 4.25 percent -- its first emergency rate cut since the days after the September 11, 2001 attacks in the United States.

It was also the second cut this month. The central bank had cut rates by 25 basis points hours after a concerted rate cut among major central banks world wide aimed at boosting market confidence in the face of the deepest financial crisis in decades.

Bank of Korea Governor Lee Seong-tae told reporters the central bank was also considering its first ever purchase of commercial bank bonds to put cash into the financial system.

"We have not decided how much liquidity we would inject with bond purchases, but we are considering 5-10 trillion won ($3.5-7.0 billion)," he told reporters.

Some analysts said the central bank may need to make more rate cuts.

"The rate cut could help lessen the burden of household debt and play a role as a stepping stone to boost the economy ... Additional rate cuts are possible. A cut in rates might take place in December but more likely early next year," said Cho Seong-joon, economist at Meritz Securities.

South Korean household debt totaled about 500 trillion won by the end of August. The ratio of debt to disposable income has risen sharply, especially debt to non-bank lenders, which charge higher rates than banks.

The central bank also cut its special interest rate for small- and medium-sized companies by 75 basis points. These companies are the country's main employers, accounting for about 90 percent of the workforce.

BOOSTS SPENDING

President Lee Myung-bak is a budget speech to parliament said the government planned to further boost spending and cut taxes next year and stood ready to inject liquidity into the system until markets calm.

"The government plans to expand the role of fiscal spending in the face of the global downturn in the real economy," Lee said, putting priority on capital expenditure and funding to small-and-medium businesses and the service sector.

"Next year, we will increase disposable income through tax cuts equivalent to 13 trillion won and stimulate investment."

Lee came to power in February but has struggled to implement sweeping economic reforms he had promised because of strong opposition.

He said he would press on with deregulation of the financial sector despite the crisis.

"We cannot leave a financial industry that is lagging in competition compared to the scale of our economy," he said. "On the other hand, we need to strengthen credit review and supervision of the safety of assets."

MARKETS FAIL TO TAKE HEART

But financial markets failed to take much heart from Monday's moves, which follow more than $130 billion already offered this month by the government to help local banks and a teetering construction industry.

The main share index fell below 900 for the first time since January 2005.

By 12:03 a.m. EDT, it had recovered slightly to 908.50, down 3.22 percent on the day and about 37 percent so far this month alone.

The won, Asia's worst-performing currency monitored by Reuters, was also down at 1,439.80 per dollar. It has shed more than a third since the start of the year.

President Lee has already warned that Asia's fourth-largest economy faces even graver danger than during the 1997/98 Asian financial crisis, when the country was only rescued from sovereign default by a $60 billion International Monetary Fund-led bailout.

But the government has said its currency reserves of about $240 billion -- the world's sixth-largest -- and a sounder economy mean it is not looking to the IMF for help this time though even though it could take longer to emerge from this crisis.