S. Korea raises worrying pitch on weak yen, rate cuts restricted

South Korea on Wednesday raised its worrying pitch on the prolonged weakness of the Japanese yen, which would dent competitiveness of domestic exporters, but the central bank kept its stance that the effect of further rate cuts to respond to the weak yen would be restricted.

"External risks, including the tapering of the U.S. quantitative easing, the weak Japanese yen and political unrest in the Middle East, expanded amid continued difficulties in the domestic economy caused by a faltering investment sentiment and a sluggish consumption recovery," the Finance Ministry said in the Green Book, its monthly report on economic conditions.

It was the first time in three months that the ministry picked the weak yen as one of risk factors to the economy.

The strong dollar trend, which came from expectations for the earlier-than-forecast rate hike in the United States, caused the depreciation of both the South Korean and Japanese currencies, but the yen fell at a faster pace than the won.

The won/yen exchange rate recently fluctuated around 9.5 won per yen, the lowest level since August 2008.

The U.S. Federal Reserve was widely forecast to raise interest rates earlier than expected, and the Bank of Japan could continue to print money, leading to expectations for the protracted yen weakness for the time being. The Bank of Korea lowered its policy rate by a quarter percentage point to 2.25 percent in August.

Finance Minister Choi Kyung-hwan said during a meeting with economy-related ministers that the weak yen has been one of major downside risks to the economy, vowing to take aggressive measures against it.

Choi said the government will halve a premium of insurance to protect small exporters, which mainly depend on Japan for exports, from the won/yen exchange rate volatility while offering policy funds of about 1 trillion won (930 million U.S. dollars) to the exporters within the fourth quarter of this year.

Demand for additional rate cuts became blatant from the top economic policymaker. Choi told reporters on Sept. 22 in Australia after attending the G20 meeting of finance ministers and central bank chiefs that he met with South Korean central bank governor Lee Ju-yeol, saying Lee may have recognized what he wants from the central bank though they directly talked about the interest rate policy.

During a parliamentary audit of the South Korean central bank on Tuesday, opposition lawmakers grilled Lee about whether Lee and Choi exchanged views on further rate cuts, worrying about the damaged independence of the central bank.

Lee told lawmakers in response that it would be better for a figure who can affect markets to refrain from making comments, casting an indirect blame on Choi for his remarks.

Regarding the weak yen, Lee said he "is closely watching" the yen depreciation, but reiterated that the central bank should be cautiously taken "to respond to the falling won/yen exchange rate with interest rate policy."

The finance ministry worried more about the protracted trend of the weak yen as Japanese exporters, which compete globally with South Korean companies in many industries, indicated a price cut of export items, which would lead to weaker price competitiveness of local exporters.

Expectations are running high for another rate cut, which may come as early as this month's rate-setting meeting scheduled for Oct. 15 when the central bank's growth outlook for 2014 is highly likely to be revised down.

Governor Lee said on Monday that the central bank was estimating the economy's potential growth at the mid-three percent level. The bank downgraded its 2014 growth outlook to 3.8 percent in July.

The ministry worried more about the domestic economy, saying the momentum of economic recovery remained fragile due to the continued low-price trend and the first reduction in three months of industrial output.

Consumer prices rose 1.1 percent in September from a year earlier after gaining 1.4 percent in the prior month.

Production in the mining and manufacturing sectors declined 3.8 percent in August from a month earlier, the first decline in three months.