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The Peninsula

South Korea’s National Assembly and the Issue of Household Debt

Published July 19, 2013
Category: South Korea

By Jongsung Kim, Ph.D.

Earlier this month, the Strategy and Finance Committee in the Republic of Korea’s National Assembly held a hearing on the household debt policies (가계부채 정책  청문회) in Korea. The rising household debt in Korea is a critical issue, and a clear symbol of its importance was the high level of government officials testifying at the hearing. The high profile of government officials having a hearing on this topic early in the legislative year demonstrates the desire in Korea to understand and resolve this problem. As I recently wrote in a report for the Korea Economic Institute of America’s Academic Paper Series (APS), tackling and reducing household debt will be vital for the recovery, stability, and future growth of South Korea’s economy.

At the hearing, eight government agencies were represented, including the Governor of the Bank of Korea Kim Choong-soo, the Minister of Strategy and Finance and Deputy Prime Minister Hyun Oh-seok, and the Minister of Land, Infrastructure, and Transport Suh Seoung-hwan. The Strategy and Finance Committee itself also has high profile members on it, such as Moon Jae-in, who last year ran for president of Korea, and Ahn Chong-bum, who was an economic adviser to Park Geun-hye during her presidential campaign. Even President Park Geun-hye has pledged to reduce household debt, and her National Happiness Fund is part of that effort. Often in democracies, it takes the attention of top leaders to address and create pathways toward solving these important issues. Thus, it is a good sign that the National Assembly and the Park Geun-hye administration are talking about household debt.

The leaders in Korea are talking about household debt because the numbers are staggering. According to Bank of Korea statistics, Korea’s household debt, tracked by the amount of household credit, reached 961.6 trillion won (841.9 billion USD at the exchange rate of 1 USD = 1142.2 won on July 9, 2013), a 4.9 percent year-over-year increase. This amount is more than double the level recorded in 2003 at 472.1 trillion won. Forty eight percent (462.3 trillion won) of the debt was extended by non-banking financial institutions that impose fewer restrictions in offering a line of credit but charge higher interest rates. Moreover, the share of Korea’s household debt to its nominal GDP rose from 72.9 percent in 2003 to 91.1 percent in 2012, and the share of household debt to disposable income rose from 126.5 percent to 163.8 percent during the same period. Lastly, the amount of household debt has increased 58.7 percent from 2006 to 2012.

During the hearing, National Assembly members argued that “the level of household debt reached a point where it not only shrinks domestic demand but also hoists down economic growth momentum and even weakens the stability of the financial system.” They also added that the rising ratio of household debt to disposable income may significantly affect the vulnerable group with low income. The high proportion of the variable rate home equity loan, 54.6 percent at the end of 2012, was also brought up as a risk factor for household debt in a recent report by the National Assembly Budget office. According to the report, those rates were 10 percent in the U.S. 13 percent in France and 10 percent in Germany by the end of 2009.

However, Hyun Oh-seok, Minister of Strategy and Finance and Deputy Prime Minister, differed in his observation and remarked that the current volume of debt could delay recovery, but it is not at the crisis-level that presents an immediate threat to the economy. The Ministry of Strategy and Finance argues this point by noting that household debt is concentrated in the high income earner groups that have more ability to service the debt. Forty nine percent in the 5th quintile’s (top 20 percent) share of total household debt stands at 49.8 percent whereas that of the 1st quintile (bottom 20 percent) is only 3.7 percent. While the percentage breakdown is correct, the Saenuri Rep. Lee Hahn-koo worried that “if the economy and the size of disposable income continue to grow at the current rate, the low-income bracket will be hit the hardest in the next year or two.”

While the Ministry of Strategy and Finance may argue there is no immediate threat to the economy, I argue in my APS paper that the South Korean government and society must take immediate steps to address the problem. The high level of household debt directly impacts too many areas of Korea’s economy to be ignored. First, the rising household debt will reduce savings and investment which can slow down economic growth and potential economic growth rate. Also the lower savings rates can make the Korean economy more dependent on foreign capital and susceptible to the fluctuations in the global financial markets. Second, as the household debt rises, private consumption and demand in the housing market will decline, hampering economic growth. Third, the mounting household debt may lead to insolvency when debtors are unable to repay their loans on time, creating instability in the financial system. Fourth, if the number of households struggling under heavy debt burden rises, the government may need to step in and increase its subsidies (or transfer payments), which will correspondingly raise government debt. Fifth, when the household debt is rising or has reached a critical point, the government will not be able to freely use interest rate policy to stabilize the economy and control inflation by increasing interest rates as such a move will put households into a more difficult financial position because they will be burdened with higher interest payments. Sixth, the rising household and government debt can make the Korean economy more vulnerable to exogenous shocks. To the extent that the existing size of household and government debt is viewed as a structural weakness, an event such as a global financial crisis will lead to insufficient foreign currency reserves due to capital flight and fluctuations in exchange rates. In turn, this may negatively affect Korea’s international credit rating. Lastly, the rise of household debt can also exacerbate income inequality, creating uncertainty and instability in Korean society.

With the crucial necessity of reducing household debt, the South Korean government should look for job creation opportunities, especially among the least privileged. Microfinance and petty loans are needed for this group of people as well. More information on new loans and new government policies being implemented to address household debt will also be critical for South Korean citizens to better understand their options and to help them reduce their debts more quickly.

The numbers, the high profile hearing at the National Assembly, and the impact on multiple areas of Korea’s economy all demonstrate the importance for addressing the household debt issue. Korea needs to address the rising household debt problem in a more proactive manner by adopting the recommendations grounded in the more fundamental areas in its economy and society. Doing so can alleviate this serious problem to Korea’s economy and provide greater strength and flexibility for growth and stability in the domestic and international markets.

Dr. Jongsung Kim is Professor of Economics at Bryant University in Smithfield, Rhode Island. The views represented here are his own.

Photo from Rep. Suh Byung-soo’s website.

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