Caution remains on overspending
By Sharon Lam
Morgan Stanley economist
Koreans love to shop. I often learn about the latest fashion trends from my Korean friends. What handbags are in, what watches are out, Koreans know it all. They love designer brands.
While many market observers focus on the consumption potential in China, Korea is one of the biggest markets for many global designer brands. Sales at Louis Vuitton have increased almost three-fold in Korea since 2006. Sales at Gucci also have almost doubled in the past five years.
One of the consequences of this love of shopping is a low savings rate. Korea's household savings rate currently stands at only 2.8 percent, one of the lowest in the world. It is well below that of emerging Asian countries like China with 28 percent and India with 32 percent, and similar to or just lower than that of developed OECD countries such as Japan with 2.7 percent, the U.K. with 4.4 percent and the U.S. with 5.7 percent.
Are Koreans overspending? There is no theory to say that one country cannot survive with a low single-digit savings rate, so I cannot prove Koreans are overspending on a structural trend.
However, cyclically speaking, there is evidence that Koreans have been overspending since 2009. When calculated in real terms, i.e. stripping away the impact of price changes, household consumption growth has been outpacing income growth since the second quarter of 2009, except in the second and third quarters of 2010 when consumption and income growth were at the same pace.
The overspending in 2009 could be partly justified by the pent up demand from 2008 to early 2009 when the economy was dragged down by the global recession. However, I think such an overspending trend has extended for too long into 2011.
Especially in the face of inflation, household real income growth has dipped into the negative territory for two consecutive quarters since the fourth quarter of 2010, meaning inflation is higher than nominal income growth.
With such deteriorating purchasing power, Koreans should have tightened their purse strings but they have not. Department store sales have continued to surprise on the upside with an average 14.1 percent year-to-year growth in the first quarter, which strengthened to 15.1 percent in April.
Sales growth of luxury goods at department stores was particularly robust at 29.5 percent in the first quarter and 43.2 percent in April. This echoes the argument on the pursuit of brand names by Koreans. Not only are they overspending, they could be overspending on luxury items.
How are Koreans sustaining this level of overspending when Korea has negative real income growth and such a low savings rate? In particular, during times of inflation, shouldn’t spending be reduced given the lack of savings?
Or could it be the wealth effect? Although the KOSPI hit a record high in May, property prices have only seen mild growth. Even if consumers are spending on the back of the wealth effect from the stock market, I suspect it could be just paper money wealth.
Since earlier this year, I have been warning that if consumption in Korea does not decline, Koreans could be borrowing to consume. I am afraid this is happening.
In the first quarter of 2011, almost 1 million new credit cards were issued every month. Every economically active Korean now has on average 4.9 credit cards on hand, a record high and higher than the average of 4.3 cards per person during the credit card bubble in 2002. The increase in credit card issuance since 2010 is a result of intense competition among credit card companies.
Having several credit cards in one’s wallet can make it tempting to consume more than one's current income. It is especially dangerous during inflationary periods, e.g. when an individual with little savings wants to continue spending despite the higher prices, then he or she needs to resort to credit cards.
Credit card usage is indeed on the rise. Credit card expenditure per person has risen to 5,286 won per person in the first quarter of 2011 from 4,685 won in the first quarter of 2009, but below the average of 6,751 won in 2002.
The situation we are seeing now is not as serious as it was during the credit card bubble but it is something that requires close monitoring. It took Korea a few years to repair the household balance sheets following the bursting of the credit card bubble in 2002.
The household loan delinquency ratio has remained at lower than 1 percent since 2007. We certainly do not want to see such efforts wasted.
I am bullish on the Korean economy on the back of its export competitiveness, disciplined capital expenditure and strong fiscal account.
I think these factors can continue to bring growth and stability to Korea. Koreans can continue to enjoy their love of shopping with decent income growth, as long as the savings rate does not drop into negative territory.
However, overspending could lead to over-leverage if it is not carefully controlled. Household debt could be a problem for Korea if households do not start showing some restraint immediately.