Soaring inflationary pressure and the ripple effects of the base rate spikes by the US Federal Reserve are expected to lead the Bank of Korea (BOK) to raise its base rate at least three times during the remainder of 2022.

Korean firms rely primarily on indirect financing for their financial needs as the Korean capital market is strongly bank-based. However, small and medium-sized enterprises (SMEs) are far more dependent than large corporations on indirect financing. Monetary policy changes involving interest rates therefore exert a significantly greater impact on SMEs than they do on large corporations, and changes in monetary policy are estimated to transfer greater costs onto SMEs than onto large corporations. Whether in the short term or the long term, the burden of rising interest rates faced by SMEs is greater than that faced by large corporations.

Low liquidity, high inflation rates, negative consumer sentiment, and excessive outstanding debt all threaten to increase risks to Korean capital markets today. Industries dominated by SMEs are expected to see their interest coverage ratios drop significantly and the percentage of zombie firms1) grow amid waves of rising
interest rates.

Proactive policy action is needed to minimize the repercussions of rising base rates on industries where SMEs are concentrated. Textiles, pulp and paper, and metal processing are among the industries with significant proportions of SMEs as well as unhealthy firms. In order to mitigate the impact of high interest rates on these
industries and enable them to achieve stable restructuring in both the short and long run, it is critical to provide policy support specifically targeted to unhealthy firms and also to introduce measures for reducing these industries’ dependency on indirect financing and supporting measures to encourage greater use of direct financing, such as support for the bonds market, for example.