By Jongsung Kim
According to a recent Bank of Korea (BOK) release, Korea’s household debt reached its historically highest level at the end of the third quarter in 2014. The report shows that at the end of September 2014, the household debt registered at 1,060.3 trillion won, a 6.7 percent year-on-year increase (993.6 trillion won) and a 2.1 percent quarter-on-quarter increase (1,038.3 trillion won) from 2013. Consequently, the share of household debt to disposable income in Korea is the 7th highest (164 percent), and its rate of growth is the highest among the OECD countries. Not surprisingly, this rise in household debt has been continuously identified as the weakest link that threatens to unravel the Korea’s economy.
This rise is partly due to the large increase of residential mortgage loans driven by low interest rates and relaxation of loan-to-value (LTV) and debt-to-income (DTI) regulations. Last February, President Park Geun-hye announced ambitious three-year economic plans to overhaul the Korean economy by restructuring the fundamental inlays of Korean economy. One of the plans, nicknamed as the “474 vision”, aims to attain 4 percent economic growth, 70 percent employment rate and $40,000 GDP per capita. The current domestic and external economic conditions facing Korea make these goals, if not impossible, certainly daunting requiring new massive stimulus policies.
In attempts to spur Korea’s economy, a series of economic policies were implemented. Among those followed the new Finance Minister Choi Kyung-hwan’s July 24th policy briefing announcement was the relaxation of lending rules as part of the stimulating policies. This effort, however, had the secondary consequence of increasing Korean’s household debt by 11 trillion won within two months.
As I previously wrote in a report for the Korea Economic Institute of America’s Academic Paper Series (APS), it is imperative that policy makers in Korea take more aggressive measures to reduce the household debt for economic stability and growth. The alternative at minimum should be to reframe policies to have the smallest impact on household debt possible.
The most conspicuous aspect of Korea’s household debt is the alarming speed at which it has been rising. According to OECD statistics, Korea’s household debt has increased 8.7 percent on average from 2008 to 2013. This is in huge contrast with the decline of household debt in the U.S and Japan during the same period. What is less obvious on the surface, but equally important, if not more, is the nature of the household debt. Approximately 20 percent of Korea’s household debt was incurred by individuals with low credit rating in the form of so-called “livelihood loan,” money necessary for living expenses. In addition, over half of debtors have multiple loans borrowing from and indebted to more than three lenders.
In 2013, the share of loans from the secondary financial institutions for the 4th income quintile rose from 24.1 to 29.4 percent. This signals that the household debt problem in Korea has permeated into the upper-middle-income groups (4th income quintile). The loans from the secondary financial market are associated with higher interest rates, thus raising the financial burden on the debtors. All in all, I expect that without a better economic performance in the years to come, Korea’s household debt problem will continue to persist. Having read the press release and supporting materials from the Korea’s Financial Services Commission (FSC) for the first anniversary of the National Happiness Fund (NHF) – President Park’s election pledge to relieve household debt and to support the credit recovery for the indebted, I found that the outcomes of the NHF are impressive as far as numbers in certain areas. For example, by March 2014, the NHF has accommodated approximately a quarter million cases of debt restructuring. However, it is still early to predict whether these beneficiaries will comply with the NHF repayment criteria and make timely payments since most of them are earning very little. For instance, a typical beneficiary earns an average of 5 million won annually (less than US $5,000) when their average debt is over 10 million won. Also, approximately 45,000 applicants (about 15 cent) failed to receive the NHF assistance for one reason or another including their failure to properly document their debts and assets as well as their ability to repay. Considering the fact that these individuals are the weakest link that should have been protected by the program, the skeptics may argue that NHF did not help every qualified person.
I am also concerned that the high household debt will continue to retard private savings and consumption, which will consequently work against the overall economic growth. With respect to other government polices to relieve other types of debts, I am still awaiting the data to fill in the details which I assume to be possible in a year or two when the numbers regarding the efficacy of the NHF and other debt-relief programs in Korea become available.
The latest release from BOK, however, states that Korea’s economy is stagnating. And there is concern that it may enter the deep recession period much like that of Japan. While stimulating the real estate market may be seen as a quick way to economic recovery, it turned out to exacerbate the household debt.
No one is a clairvoyant when it comes to economic recovery. However, the lessons of the past indicate that everything has to be moving in sync. There has to be a combination of government lowering the interest rates for an extended period of time and loan regulations, which may include higher costs and interests for speculative investment purposes while promoting reasonable interests to stimulate the small to medium business enterprises with government subsidies, to encourage these businesses to practice social policies for their employees.
Together, with restructuring of the tax code to put more money back into the pockets of the lower and middle income classes, the average consumer will not have to resort to taking out loans to finance so called their “living expenses” or take out easy loans for excessive speculations which could begin a annihilation spiral.
There are no sudden miracles to reduce household debt immediately in Korea. However, with proper policies and practice, such a goal can be achieved in the long run and in a more consistent basis.
Dr. Jongsung Kim is a Professor of Economics at Bryant University. The views expressed here are the author’s alone.
Photo from Ian Muttoo’s photo stream on flickr Creative Commons.