Concerns about a vicious cycle of rising interest rates and inflation amid debates between the ruling and opposition parties’ ‘question and double’ supplementary budget

There are concerns that a series of additional supplementary budgets (additional budgets) could fuel loan interest rates and inflation. The main cause is the issuance of KTBs, which is out of the market’s digestibility. Politicians are calling for an increase in the size of the supplementary budget from 14 trillion won (government plan) to 35 trillion won or 50 trillion won. If this becomes a reality, the adverse impact on interest rates and inflation will be even greater.

At the cabinet meeting on the 21st, the government prepared an additional budget of 14 trillion won to support small business owners and the self-employed and to reinforce quarantine measures. The goal is to provide an additional 3 million won in quarantine subsidies to small business owners and self-employed people who have suffered damage due to the novel coronavirus infection (COVID-19) quarantine measures. To this end, the government will issue 11.3 trillion won of deficit government bonds. This is because the excess tax revenue from last year can be utilized only after the ‘2021 fiscal year settlement’ in April.

The government will submit the supplementary budget bill to the National Assembly on the 24th. Already, discussions are in full swing in the political circles to increase the supplementary budget. Democratic Party presidential candidate Lee Jae-myung proposed an emergency meeting with the presidential candidates on the 21st to prepare an additional budget of 35 trillion won. People’s Strength candidate Yoon Seok-yeol practically rejected Lee’s proposal and offered ’50 trillion won’ as the minimum supplementary budget for the meeting.

The government has been managing finances in the direction of minimizing the issuance of government bonds in consideration of the burden on the bond market caused by the formation of the additional budget six times since 2020. In the second supplementary budget last year, 2 trillion won worth of government bonds were repaid early, and year-end government bond issuance was reduced by 2.5 trillion won. Nevertheless, this year’s supplementary budget was organized because excess tax revenue of more than 10 trillion won can be used for early repayment of government bonds in the future.

The problem is that government bonds are being issued at a level that exceeds the digestibility of the bond market due to the increase in the supplementary budget. In this case, a demand advantage occurs, causing the price of government bonds to fall (the interest rate rises). Treasury bond yields are already on an upward trend due to the influence of the base rate hike and other factors. In particular, COFIX, which is the standard for loan interest rates as a financing cost for banks, is affected by the interest rate on government bonds. If the interest rate on government bonds rises, small business owners and self-employed people with large loan balances may have to pay more interest on loans than that, even if they receive additional quarantine support and loss compensation. This is the so-called ‘construction effect’, in which the expansion of fiscal spending actually shrinks private consumption and investment.

Excessive fiscal spending can also boost inflation. Deputy Prime Minister and Minister of Strategy and Finance Hong Nam-ki recently said, “(In the government proposal), the direct impact on prices is limited because most of the supplementary budget is transferred to the self-employed and small business owners. I can’t help but be concerned,” he said.

Last year, the annual consumer price index increased by 2.5%. This year, there is a possibility that the increase will be further expanded due to the base effect caused by low inflation in the first half of last year and the increase in demand due to the anticipation of the end of Corona 19.