The Bank of Korea raised its base rate for the first time in three and a half years, embarking on monetary tightening, while the government formalized plans for a record-breaking expansionary budget exceeding ₩800 trillion (approximately $577.5 billion) for the first time in history. As the monetary authority tightens the money supply, the fiscal authority is simultaneously unleashing money at an unprecedented scale — a policy collision that is now materializing and amplifying concerns over interest rate instability and fiscal soundness.
The Bank of Korea raised its base rate from 2.50% to 2.75% on the 16th of last month, with all seven monetary policy board members voting unanimously. A base rate hike is a measure to withdraw money from circulation and stabilize prices. Conversely, when the government increases spending, money flows into the economy and stimulates inflation. The process of issuing government bonds to cover fiscal shortfalls also exerts upward pressure on market interest rates. Observers note that when one side tightens the money supply while the other loosens it, the economy can fall into a vicious cycle requiring even higher rates to control inflation.
The impact of tightening is already visible in the lending market. According to the Korea Federation of Banks on the 21st, the July new COFIX (Cost of Funds Index) rose 0.13 percentage points from the previous month to 3.18%, marking four consecutive months of increases. The balance-based COFIX, which reflects past funding costs, also climbed to 3.00%, its highest level since the end of last year.
The high-interest-rate shock is cutting deepest into the most vulnerable segments of the economy. The volume of so-called “empty-shell loans” at commercial banks — loans that generate no interest income — has surpassed ₩6 trillion (approximately $4.3 billion) for the first time ever. Non-performing loans (principal and interest more than three months overdue) at the five major banks reached ₩6.41 trillion (approximately $4.6 billion) at the end of the second quarter this year, surging 28% in just six months. The ratio to total credit rose to 0.34%, the highest since the second quarter of 2020 during the COVID-19 outbreak. Corporate loan defaults, hit directly by the domestic demand slump and real estate market slowdown, soared 36.4%.
₩800 Trillion Budget and ₩100 Trillion Future Response Fund
While financial markets groan under the weight of tightening, fiscal authorities have played an expansion card of unprecedented scale. Park Hong-keun, Minister of Economy and Finance, announced at the National Fiscal Strategy Meeting on the 13th of last month that “2027 national tax revenue will far exceed the original projection of ₩412 trillion (approximately $297.4 billion), reaching a record ₩500 trillion+α (approximately $360.9 billion),” and stated that next year’s total expenditure would increase by more than 10% from this year. This formalized the first-ever budget exceeding ₩800 trillion.
Some securities analysts project actual spending could reach as high as ₩840 trillion (approximately $606.4 billion). Compared to this year’s main budget of ₩727.9 trillion, that represents an increase of over ₩72 trillion (approximately $52.0 billion) — the first double-digit annual spending growth rate since the global financial crisis response in 2009.
On the 21st, the government held the first Fiscal Management Strategy Council meeting at the Seoul Government Complex, attended by Minister Park and other relevant cabinet members, where the “Future Response Fund Implementation Plan” was presented and discussed. The concept is to divert surplus tax revenue — expected to surge due to the semiconductor industry boom — into a separate fund for investment rather than using it for debt repayment.
The fund’s primary source is a newly defined concept of “additional tax revenue.” The portion of next year’s internal tax revenue budget that exceeds the trend line calculated from the 10-year average annual growth rate of internal tax settlements will be transferred from the general account to the fund. This will be supplemented by surplus tax revenue identified during the September revenue re-estimation, remaining world surplus funds, and returns from idle fund management.
While specific fund size figures were not disclosed, estimates based on Minister Park’s announced national tax revenue projection of ₩500 trillion and the ministry’s formula suggest that over ₩100 trillion (approximately $72.2 billion) could be injected in the first year alone. That amounts to one-third of this year’s Public Capital Management Fund operations (₩328.1 trillion).
The fund will concentrate on four major areas: youth, growth engines, regional development, and education/talent. The youth segment covers life-cycle support including jobs, housing, and marriage/childbirth. The growth engine segment targets investment in seven future technologies including AI leadership, small modular reactors (SMRs), quantum computing, and aerospace. The regional segment focuses on improving living conditions and expanding basic income for agricultural and fishing communities. The education/talent segment supports cultivating outstanding STEM talent and attracting foreign talent.
Concerns Over “Pocket Money” Beyond Parliamentary Control
The problem lies in the control mechanisms. The fund allows up to 20% of major expenditure items to be reallocated without parliamentary approval. While the National Finance Act stipulates securing fiscal soundness and maintaining appropriate national debt levels, critics point out that the government has opened a new channel for expansionary fiscal policy even as discussions on fiscal consolidation legislation have made no progress. This year’s deficit-generating debt has already exceeded ₩1,000 trillion (approximately $721.9 billion), and next year’s budget is projected to exceed ₩800 trillion.
Responding to criticism that the fund could become the government’s “pocket money,” Minister Park countered: “The fund operates under the Fund Management Act and the National Finance Act, following established controls and procedures. We cannot do as we please. It will naturally be executed subject to National Assembly deliberation and legal grounds.”
The Ministry of Economy and Finance maintains that the fund allows for flexible operation by enabling rapid response within the scope approved by the National Assembly. The Future Response Fund is scheduled for legislative notice as a “Future Response Fund Package Bill” on the 24th, followed by a Cabinet meeting next month, and submission to the National Assembly along with the budget proposal on the 3rd of the following month.
Academics Split: “Pouring Fuel on an Overheated Economy” vs. “Investment for the Future”
Academics warn that attention should focus on the “absolute scale” of expanding fiscal spending rather than the growth rate alone. Kim Woo-chul, professor of tax studies at the University of Seoul and president of the Korean Association of Public Finance, said: “A 10% increase when national fiscal scale is ₩500 trillion is completely different in absolute terms from a 10% increase when it has already surpassed ₩720 trillion (approximately $519.7 billion). After the fiscal expansion during the COVID-19 response, pouring massive fiscal stimulus into an overheated economy is like adding fuel to the fire — a serious problem.”
The deficit scale is also contentious. Despite collecting more tax revenue than expected this year due to the semiconductor boom, the actual fiscal deficit (managed fiscal balance) reached ₩107 trillion (approximately $77.2 billion). The government must issue national debt to fill this hole entirely. Professor Kim noted: “Even this year, with higher tax collections, we ran a deficit exceeding ₩100 trillion. Claiming we’ll reduce the deficit while increasing spending by double digits is contradictory. No matter how optimistically the government projects tax revenue, it ultimately means borrowing to cover most of the shortfall.”
Voices questioning the very premise of expansionary fiscal policy for economic stimulus are also growing. Seok Byung-hoon, professor of economics at Ewha Womans University, said: “With strong semiconductor exports, growth is expected to exceed potential growth rates both this year and next. There is no reason to artificially stimulate an economy that is not in recession by aggressively loosening fiscal policy.”
On the other hand, counterarguments that government spending must serve as priming water for future growth industries are equally forceful. Kim Jung-sik, professor emeritus of economics at Yonsei University, said: “Major governments worldwide are pouring astronomical fiscal resources into securing leadership in future core industries like AI. Even if fiscal soundness is somewhat compromised in the short term, government intervention is necessary at this juncture to secure long-term national industrial competitiveness.”
The Bank of Korea also views the government’s fiscal role in supporting vulnerable sectors positively. Shin Hyun-song, Governor of the Bank of Korea, stated: “If fiscal policy translates into productive investment that raises future potential growth rates, it is difficult to characterize it as being out of step with rate hikes. Fiscal and financial policies are better suited to supporting vulnerable groups hit by high interest rates.”
Bond Market’s Cold Response
The bond market’s response has been chilly. Despite projections that next year’s government bond issuance will fall to around ₩190 trillion (approximately $137.2 billion), down from this year’s ₩225.7 trillion, bond yields are moving in the opposite direction. On the 14th, 30-year government bond yields in the Seoul bond market rose 0.15 percentage points in a week to 4.67% annually — a jump of more than 1.4 percentage points since the start of the year.
The fact that long-term yields are rising despite reduced government bond supply reflects market anxiety that government spending will re-stimulate inflation and ultimately return as a future fiscal burden. Kim Sung-soo, an analyst at Hanwha Investment & Securities, noted: “Given solid growth and fiscal uncertainty, investors should remain cautious about long-term government bond investments.” The analysis suggests that long-term rates will struggle to stabilize as long as concerns over government fiscal management persist.
Ultimately, the core issues are spending structure and revenue sustainability. The current tax revenue boom relies heavily on semiconductors, and if industry conditions deteriorate and tax revenue declines, the government could face a “fiscal cliff” unable to sustain expanded spending. Ahn Dong-hyun, professor of economics at Seoul National University, advised: “One-off investments can be reduced depending on circumstances, but fixed expenditures like welfare benefits, once increased, are difficult to reverse and must be approached with extreme caution. Investment for the future and recurring fixed costs must be clearly distinguished.” Professor Seok Byung-hoon added: “Rather than exhausting all surplus tax revenue from the semiconductor boom on spending, a portion should be allocated to repaying national debt to build a buffer against future shocks.”