(EDITORIAL from Korea Times on Sept. 18)

The shift from cheap capital to higher borrowing costs demands reforms to boost productivity and enhance financial stability, as South Korea grapples with the reality of rising yields. The 10-year US Treasury yield has broken above the 5 percent mark, with the Federal Reserve raising its benchmark rate by 25 basis points to 3.75 to 4 percent, the first increase since July 2023.

This change is due to factors such as oil prices above $100 per barrel, conflict in the Middle East, and substantial investments in AI infrastructure. Additionally, US fiscal policy has increased the demand for a larger premium to hold long-dated government bonds, as South Korea's gross public debt has climbed above 110 percent of its GDP.

The special advantage of Treasurys as safe assets has weakened, and there is a risk that governments may issue more short-term debt to avoid locking in current high yields, exacerbating the problem. Higher government bond yields will eventually impact corporate borrowing costs and bank lending rates, squeezing businesses and households.

The Bank of Korea has tightened policy, raising its rate to 3 percent for two consecutive meetings in July and August, the first back-to-back tightening since January 2023. However, simply matching the Federal Reserve's moves would be poor monetary policy, and the Bank of Korea should set clear conditions for further increases while considering domestic inflation, exchange rates, and credit conditions.

Household credit has exceeded 2,000 trillion won, and corporate debt is nearing that level, putting pressure on borrowers with limited capacity to absorb higher interest expenses. Fiscal policy must also address its burden, as large-scale government borrowing can further increase market rates and consume a larger share of the budget.

To improve competitiveness, regulatory reforms are needed to lower barriers to market entry, increase labor market flexibility, and strengthen productivity incentives. While rates may eventually fall, it is unclear when, and South Korea should prepare for expensive capital to persist long enough to reveal overextended finances and unproductive investments.

The focus should now be on ensuring that every unit of capital generates measurable returns before higher borrowing costs become a permanent drag on growth.