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IMF urges Korea to cut rates to stave off deflation risk

[WASHINGTON] The current slowdown in South Korea's economy could devolve into a protracted bout of deflation, the International Monetary Fund warned on Friday, urging the country's central bank to cut rates.

The IMF also said the Korean won remains undervalued, and should be allowed to rise over time.

But the immediate risk was that current stalled growth and weak inflation becomes "entrenched" as the country's export dependent economy struggles with weak global demand.

The country's poor performance has led businesses to curb investment and caused households to engage in "cash hoarding," a situation that may be difficult to reverse unless it is done soon, the IMF said.

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Korean rates are already at a historic low of 1.75 per cent, the fund noted, leaving the Bank of Korea close to the zero lower bound, beyond which unconventional measures would be needed for further stimulus. "There is scope for monetary policy to take pre-emptive action ... In an environment where households and firms hold excess cash and postpone spending on the self-reinforcing expectation that wages, prices, and house price growth may continue to be weak, policy rate cuts can help shift incentives away from cash hoarding toward more consumption and investment," the fund said in its annual Article IV report on the country. "The longer expectations become entrenched however, the more policy rates would need to be cut to break this dynamic."