KoreaToday Korean households sinking under debt burden

By Kim Tong-hyung

Despite all the self-congratulations over how Korea managed to ride out the global economic turmoil, it’s becoming harder to overlook one inconvenient truth: the historically high levels of Korean household debt, if left unattended, will eventually rattle the country’s financial stability flesh and bone.

Key government economic units, including the Ministry of Strategy and Finance and the Bank of Korea (BOK), have been downplaying concerns that the country could be heading toward an economic crunch caused by collapsed family finances. However, the policymakers find themselves defending against a growing number of observers predicting that household debt will soon emerge as a considerable threat to the economy, especially if interest rates were to keep going up.

As of the latest figures, Korean households now owe a near-equivalent of an entire year’s gross domestic product (GDP), which is believed to have passed the $1 trillion mark in 2010.

Korea’s household lending by banks and other savings institutions touched 600 trillion won at the end of last year, according to government estimates. Combine this with unsecured lending, in the forms of credit cards and loans, and the borrowings by the self-employed and non-profit organizations, and the real size of personal debt could be in the territory of 980 trillion won (about $874 billion), says the LG Economic Research Institute (LGERI).

Considering that total household debt has been growing by 50 to 60 trillion won a year, the amount of money owned by consumers is expected to firmly break into the 1,000 trillion won barrier this year.

Korea’s current amount of household lending, as measured by the ratio of debt to personal disposable income, was more than 150 percent in 2010, ranked among with world’s highest with nations like Britain (161 percent) and Australia (155 percent).

After BOK announced its key interest rate by a quarter percentage point to 2.75 percent earlier this month, the bank’s governor Kim Choong-soo attempted to play down the effect of the decision on the country’s heavily-indebted households. It would be excessive to say that Korea is in debt danger, Kim said, when the growth in personal financial assets is still outpacing the booming debt.

But Kim’s words sounded more like a confession than assessment. Raising interest rates was an inevitable decision for the central bank, which is alarmed about the possibility of soaring inflation deteriorating the country’s economic recovery. Higher interest rates, however, will also increase the vulnerability of households that are already stretched to pay off their borrowings.

It would be hard for most consumers to cover this burden with income from their financial assets. Savings accounted for about 43 percent of the financial assets held by Koreans last year, while more capricious assets like stocks, shares and fund holdings, which may see their value decline in an environment of firming interest rates, accounted for nearly 30 percent.

``It appears that the country’s consumer debt is growing by 15 to 20 trillion won every quarter. The rising interest rates could further aggravate this problem and particularly affect people on low incomes,’’ said LG researcher Choi Moon-bak.

``A rise in the key interest rate usually results in banks upping their lending rates quicker than their savings rates. Thus, the increase in income from these financial assets will provide only limited help for households in reducing the burden from their debts.’’

It’s becoming harder to remember that in 1998, in the midst of the Asian financial crisis, the country had just around 183.6 trillion won in secure and unsecured household lending combined.

The borrowing binge over the past decade has been driven in large by the speculative demand on the real estate market, with low interest rates having Koreans buying property at any imaginable price in blind faith that its value will appreciate forever.

Now, with a slow economy letting the air out of the housing bubble, homeowners find themselves devastated by freefalling prices.

According to figures by BOK, the nation ended 2010 with a record 379 trillion won in unpaid mortgages debt, which rose by 4.9 trillion won in December alone, the highest monthly margin since the 5.1 trillion won of November 2006, when the property market was around its peak.

The market has been declining rapidly since the latter half of 2008, and the strength of the inflation of the past decade, which pushed homes in Seoul and neighboring metropolitan cities to be dramatically overvalued, suggests that house prices still have room to fall further.

Policymakers are obviously alarmed over the continuing house price crash, which traps homeowners longer in negative equity. The worse-case scenario for the country is a slew of homeowners, stretched to the extreme, forced to default on their mortgages, which in turn would devastate banks and the wider economy.

``Household debts in developed nations like the United States and Britain have decreased over the past because of the economic downturn, but the alarming thing for Korea is that its household debt even grew further during that span. Default rates are beginning to rise, and should the housing market fail to regain some of its old strength, household debt will pose a considerable challenge to the economy this year,’’ said Yoo Byung-kyu, a senior economist at the Hyundai Research Institute.

``Household debt has grown in Korea in a way that was similar to Britain’s experience, and it’s crucial for policymakers to prevent the current situation from rocking the economy’s financial stability and deteriorate consumption, as things were in Britain.

``The priority is to find ways to minimize the damage inflicted by the massive amount of household debt on the occasion that the economy receives another shock from the outside. The government needs a more careful and detailed analysis on the nature of the country’s household debt and its possible effects on the economy, and also find ways to improve the income of indebted low-income households.’’

The government is expected to announce a package of policies around March that aims to achieve a ``soft-landing’’ for the country’s debt problem. However, it remains to be seen whether policymakers will manage to come up with something more than piecemeal measures when the government appears caught between letting some air out of the property bubble and creating another one.

Some observers, such as the KS Economic Research Institute’s Seon Dae-in, insists that the country’s only way out of a debt mess is for the BOK to move on with further rate hikes and kill off the public’s love affair with cheap loans, despite the immediate pain that could be inflicted on households.

However, it questionable whether the central bank could show boldness in raising interest rates further, when government officials are worried that the increased borrowing costs will deter homebuyers and accelerate the sinking of the housing market.

Despite the snowballing debt, government policies have been engineered to encourage consumers to borrow even more in an attempt to halt the property skid. The most notable move was the decision to temporarily ease the debt-to-income ratio (DTI) rule, which restricts homebuyers’ borrowing in proportion to their annual income, in major housing markets.

The loosened DTI regulations continue through March, and government officials appear mixed on whether to extend the relaxed rules or not.

``The current turbulence of the housing market will be stabilized when the supply and demand regaining some of its balance, but over long term, the aging of the country’s population suggests that that home prices will continue its trajectory of gradual decline. The relaxing of the DTI rules and other measures for bumping of demand therefore inappropriate, as they may accelerate the popping of the housing bubble by sparking up prices temporarily and further deteriorate the household finances,’’ said Jang Min, a researcher from the Korean Institute of Finance.

``Considering that high-income consumers are affected more by the loan-to-value ratios (LTV) and the DTI rules have stronger influence over mid-to-low-income consumers, relaxing the DTI regulations could only aggravate the debt problem of low-income households. The government should return the DTI regulations to their original form after March and shift the focus of its policies to restoring the financial health of households rather than responding to the curves of the housing market.’’