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South Korea needs more easing, urgently

SeongJoon Cho | Bloomberg | Getty Images

The Bank of Korea (BOK) left policy unchanged for a fourth month this week, prompting criticism from market watchers who say the central bank must urgently implement monetary stimulus to lift Asia's fourth-largest economy out of the doldrums.

After leaving the benchmark policy rate at 2 percent on Tuesday, central bank governor Lee Ju-yeol said that interest rate cuts were no longer as effective in impacting the economy.

But with the country on the verge of entrenched deflation, the International Monetary Fund and HSBC are some of the voices calling on the BOK to lower rates in the coming months.

"The likelihood of a rate cut next month increases if economic data signal significant downside risks to economic growth. The central bank also noted weak domestic demand and suppressed private sentiment and we think these pose downside risks to the central bank's 2015 GDP growth forecast of 3.4 percent," said HSBC economist Ronald Mann in a report on Tuesday.

Read MoreIs South Koreaheaded for Japan-style deflation?

Mann is anticipating a 25-basis point rate cut in March, followed by a second cut in the third-quarter.

"The short-term bias should be for the BOK to cut rates," added DBS in a note. "We expect the benchmark repo rate to fall by 25 basis points to 1.75 percent by the end of the first quarter," the bank said in a recent report.

South Korea's economy grew at its slowest quarterly pace in two years during the October-December period, with growth nearly halving from the quarter before. Meanwhile, consumer prices grew 1.3 percent in 2014, falling below the average of G7 countries for the first time in eight years. Furthermore, producer prices are at their weakest level since the global financial crisis.

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Last week, the IMF warned that Korean authorities have the monetary and fiscal policy space to take action against what it called a "self-reinforcing downside dynamic."

"We urge them [authorities] to use that policy space if needed to avoid the sort of scenario we described, of self-reinforcing low inflation, low growth environment, which we've known from past experience is a very difficult dynamic to break out of once you get into it," said Brian Aitken, IMF mission chief to Korea, during a press conference.

Currency movements may also change the central bank's mind, HSBC argued. The Korean won has appreciated 11 percent against its Japanese counterpart over the past 12 months, making Korean exports significantly more expensive overseas.

"The associated downside risks to Korea's economy through the export channel may prompt more monetary easing by the Bank of Korea than that currently expected by the market," Mann said.

No central bank fix

Some experts believe the South Korean economy is beyond even the central bank's repair.

"The Bank of Korea is trying very hard to revive the economy but there's not much they can do. Whether they cut rates or not, it's not going to change Korea's situation," said David Gaud, Asia ex-Japan equity fund manager at Edmond de Rothschild Asset Management.

He believes Korea faces deep structural issues due to the dominance of massive conglomerates called chaebols, resulting in some of the lowest dividend yields among developed nations.

"Korea has a lot of cash and value but it's unlocked and we don't see [structural] reforms taking place to unlock that value."