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The Peninsula

Why Korea is Hesitant to Accommodate the IMF's Suggestion on Household Debt

Published December 19, 2016

By Jaeho Jeon

South Korea faces a household debt crisis. Household debt reached more than 1,257 trillion won ($1.1 trillion) in the second quarter of this year, up 125.7 trillion won and 11.1 percent from a year ago. This marks the highest level for household debt since the government began compiling related data in 2002. As a result, South Korea’s household debt stands at 163 percent of disposable income, or the amount of money that a household can actually spend after paying taxes or other welfare contributions. It’s also 26 percentage points higher than the OECD average of 137 percent.

Household debt in South Korea has been increasing mostly because of real estate. Apartment prices in Seoul rose about 3 percent from January to September this year. As apartment prices went up, more people rushed to borrow money to buy houses. Another driver of rising household debt has been increasing chonsei rental prices.

High levels of household debt also have significant implications for the wider Korean economy and have been widely dubbed the ‘detonator of the Korean economy.’ If household debt is increased, the disposable income of a household will be decreased. This can adversely affect domestic demand. If interest rates rise, borrowers’ debt-servicing burden will be escalated and consumption capability will be diminished. Most household debt is mortgage based, so if housing prices go down Korea could face its own version of the sub-prime crisis that hit the United States.

Many experts have suggested that the government should more strictly manage the levels of household debt. Even the IMF recently pointed out that level of household debt in Korea is high and the DTI, debt to income, cap of 60 percent should gradually be tightened toward a range 30 to 50 percent.

The IMF also suggested last August that the DTI cap should be extended to apply to other types of household debt including so-called group loans which are taken by a group of prospective apartment buyers and guaranteed by developers and public credit guarantee corporations. The IMF believes that these measures should reduce financial risks and also help consumption and growth by reducing household debt.

The Korean government has implemented a set of policies aimed at curbing rising household debt. But the latest measure did not include anything regarding DTI. Why did the government not implement strong measures like tightening the DTI cap? If we look at the statistics, we can understand the concerns of the government.

In the first half of this year, construction investment in South Korea has grown by 10.3 percent compared to the same period last year to 104 trillion won. In contrast, when compared to the first half Korea’s exports fell 10 percent in the first half. Private consumption, on the other hand, only increased by 2.8 percent in the first half.

Amid sluggish exports, the Korean economy is increasingly dependent on the construction sector for growth. GDP growth recorded 2.8 percent increase in the first quarter from the same period in the previous year and 3.3 percent increase in the second quarter.

But these figures drop to 1.6 percent each, when construction investments are excluded. Construction investment contributed to 51.5 percent of the Korean economic growth achieved in the second quarter. In contrast, they contributed to only 5.3 percent of economic growth from 2000 to 2014 on average.

Taking into account the circumstance that the Korean economy heavily relies on construction and the real estate market, the government will not likely tighten DTI as part of efforts to tackle the soaring household debt in the foreseeable future. Tightening DTI might result in a real estate market slump and failure to achieve the government’s goal for economic growth. Especially considering the South Korean presidential election next year, it is likely that the government would be reluctant to take significant measures which could reduce economic growth.

Jaeho Jeon is a reporter at ChosunBiz and a visiting fellow at the Korea Economic Institute of America. The views expressed here are the author’s alone.

Image from Francisco Anzola’s photostream on flickr Creative Commons.

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