Downside risks to South Korea's economic growth have escalated due to sputtering recoveries in advanced economies and contagion fears about the eurozone debt crisis, the top central banker warned Tuesday.
Bank of Korea (BOK) Gov. Kim Choong-soo told lawmakers that domestic economic activities are moderating while the overall economy is on an upward trend.
"In terms of upside and downside risks, downward risks are viewed as being predominant on concerns about the sluggish growth of advanced countries and the spread of the eurozone sovereign debt problems," the governor told lawmakers.
"Economic uncertainty remained high as major advanced economies' room for fiscal policies was reduced and political leadership to solve (the eurozone debt crisis) remains weak. The local economy is expected to be on a long-term growth trend, but downside risks to growth increased due to external factors," Kim said.
The BOK said earlier that if global financial jitters and economic slowdowns in advanced countries persist, the growth of the Korean economy will likely be affected by a considerable margin, raising speculation that the central bank may cut its growth estimate of 4.3 percent for this year.
The governor, however, said that current eurozone debt problems are unlikely to cause a financial crisis similar to that experienced worldwide in 2008.
Heightened external economic uncertainty is causing more analysts to bet that the BOK is likely to freeze the key rate at 3.25 percent for the remainder of this year.
The BOK said consumer prices are likely to be on the rise due to oil prices and economic growth, but the pace is expected to ease on a fall in prices of agricultural products.
"Consumer inflation is maintaining its upward trend, but the growth pace of consumer prices is expected to slow gradually," Kim said.
South Korea's consumer prices jumped a whopping 5.3 percent in August from a year earlier, surpassing the upper ceiling of the BOK's inflation target range for the eighth straight month.
According to the central bank, price gains mainly stemmed from the supply side, like hikes in oil and food prices in the January-August period.
The bank said it will manage the monetary policy by focusing on price stability while taking into account risk factors at home and abroad.
It added that it will collect the remaining 900 billion won out of its 2.1 trillion won investment in a fund aimed at stabilizing the bond markets. The fund was set up at the height of the global financial turmoil to help ease a credit crunch.
Speaking of the country's foreign reserves, Kim said South Korea can deal with global financial market uneasiness with its current level of US$312.19 billion in FX reserves.
Market players estimated that foreign exchange authorities intervened to curb a sharp drop on the won, raising speculation that Korea's foreign reserves may be insufficient to cope with an unexpected foreign liquidity shortage.
"It is not appropriate to view the current level of more than $300 billion in foreign reserves as small," Kim said. "It is hard to say whether the reserve is adequate, but we can cope with market troubles with the current volume of the reserves."
The BOK said in a report that it plans to increase its proportion of non-dollar assets "gradually" while keeping the current portfolio of its foreign exchange reserves given the prospects that the U.S. dollar will maintain its status as the reserve currency for a considerable period of time.
The BOK has been making efforts to diversify its FX reserves by curtailing the weight of U.S. dollar-denominated assets.
The proportion of the BOK's dollar holdings fell for the second straight year in 2009, but rebounded last year due to increased external uncertainty like the eurozone debt crisis.
The BOK's dollar holdings came to 63.7 percent of its foreign currency assets as of end-2010, up 0.6 percent from a year earlier.