Will household debt crush economy?

By Kang Seung-woo

Heavily indebted Korean households will be relieved as the Bank of Korea (BOK) kept the benchmark interest rate at 2.75 percent Friday.

Market watchers point out that this feeling will be short-lived as the debt level poses a threat to the nation’s overall economy.

According to the central bank, household loans stood at 770 trillion won as of the end of the third quarter of 2010, up from a year before and 581 trillion won in the same period of time in 2006.

It is likely to grow this year as the BOK is ready to hike key interest rates, which ends up raising the borrowing costs of commercial banks.

Last month, the BOK increased its key interest rate by 25 basis points to 2.75 percent, the third hike since July 2010, in its attempt to curb escalating inflationary pressure.

Although the central bank froze them this time around, the market consensus is that it will further move up the rates in the near future.

“Although the nation’s household debt has not crossed the critical line yet, it is getting close. The level is too high compared with major advanced economies, said Lee Chang-seon, managing director of the financial research department at LG Economic Research Institute.

“The worries on the rate hikes are an immediate concern to the low-income households, struggling with debts higher than assets, which could end up bad loans.”

He also said that is why the government has been trying to come up with various microcredit programs, such as Sunshine Loans and Smile Microcredit financing.

A local think tank warned that household debt is set to be more troublesome down the road, dented by rate increases.

“The country’s household debt level has spiked on the strength of low interest rates and a bullish stock market. But borrowing costs are projected to rise in the future and the stock market is expected to remain volatile. This will put more financial burdens on households,” the Samsung Economic Research Institute (SERI) said in its recent report.

According to SERI, households bear additional financial burdens totaling 4.5 trillion won ($4.07 billion) if loan rates go up 2 percentage points.

Alerted by speculation that the interest rate will continue to rise this year, people are scrambling to repay what they owe.

“Since late last year, I have paid off debts amid the current opinion on rate hikes, but I am still worried about further rate increases,” said a borrower, who did not want to be identified.

Observers say that the maturity structure of debt needs to be improved.

“A large number of household loans are extended on a short-term basis and borrowers have to repay a lump sum, so they could shoulder a bigger burden, when they are hit hard by external shocks,” Lee said.

“Borrowers had better consider shifting to long-term installment plans and fixed interest rates instead of an ones with adjustable interest.”

Lee is against the government’s plans to ease mortgage regulations, such as the debt-to-income (DTI) ratio, a measure to restrict homebuyers’ borrowing in proportion to their annual income.

In August last year, the Seoul administration temporarily relaxed the DTI regulations in its efforts to boost the slumping housing market.