INTERVIEW BOK's too-high-for-too-long stance could tip Korea into recession: Moody's Analytics

Bank of Korea (BOK) Governor Rhee Chang-yong walks in the hallway of the Korea Federation of Banks in Seoul after a meeting with financial and economic authorities, Aug. 6. Yonhap

By Lee Kyung-min

• Published Aug 18, 2024 9:56 AM KST
• Updated Aug 19, 2024 1:57 PM KST

The Korean economy faces a heightened risk of recession, strained by stalled monetary easing by the Bank of Korea (BOK), a Moody’s Analytics economist said.

Underpinning the view is Korea’s high household debt-to-GDP ratio of over 94 percent, despite the base year change that lowered the figure to below 100 percent. It is among the highest of major economies. The figure for corporate debt to GDP remains the fifth-highest.

Further amplifying the concern is weakening domestic consumption, as highlighted by a 0.2 percent quarter-on-quarter GDP contraction in the April-to-June period. It was the first quarterly retreat since the fourth quarter of 2022.

“If interest rates stay too high for too long, Korea’s economy could fall into recession,” Moody’s Analytics Associate Economist Dave Chia said in an interview with The Korea Times.

The sustained tightening continues to fan financial stability concerns, as evidenced by a rise in the number of low-income earners and small construction firms defaulting on their debts.

This coupled with surging household debt is a major red flag. The household debt-to GDP ratio of 93.5 percent was down from 100.4 percent, due to the revision of the base year to 2020 from 2015.

“Korea’s high household debt poses a long-term threat to the economy,” he said. “A recession could drive up unemployment, suppress real wage growth, and push households to default on their debt obligations.”

The series of defaults of construction firms and low-income earners earlier this year are explained by high debt-servicing costs, a serious risk factor that had been contained due to prompt action by the Financial Services Commission (FSC).

The FSC implemented measures to ensure that project financing businesses are granted maturity extensions and deferment of interest payments based on project viability.

“Authorities appear to have contained the problem and the market impact has been minimal. Lenders can support businesses and low-income earners by restructuring their loans.”

BOK rate cut likely in October

The BOK will have more room to maneuver, aided by expectations of a rate cut by the U.S. Federal Reserve in September.

This in turn will narrow the interest rate differential with Korea and help contain exchange rate volatility, a condition conducive to monetary easing for the BOK.

The analytics arm indepent of Moody’s Ratings has moved its BOK rate cut forecast to October from this month, despite domestic economic weakness underscoring the need for an early rate cut.

“The Bank of Korea’s July minutes emphasized the need for financial stability and expressed concerns about currency weakness. The rate-setting Monetary Policy Board seems inclined to wait a little longer before cutting rates.”

Korea’s household debt-to-GDP ratio exceeding 100 percent of nominal GDP is significantly higher than other large economies, a cause for concern to the long-term health of the economy.

For context, the ratios for China and Japan remain around 60.

Financial regulators can tighten lending practices and support debt restructurings, in his view.

The FSC can require banks to strengthen their capital reserves to protect against potential deficits and perform stress tests to ensure financial resilience.

“The risk of immediate and widespread defaults by households is minimal. Changes could be rolled out in phases to ensure their effectiveness and avoid major disruptions to households.”

These recommendations were in reference to Korea fortifying borrowing rules to curb household debt, as outlined by the new debt service ratio (DSR) measure.

The stress DSR is whereby credit-specific add-ons will be applied to lower borrowing limits, relative to borrowers’ income. It was set to take effect in July, but has since been postponed to September.

The Korean economy is poised to expand this year, underpinned by artificial intelligence (AI) chip exports and recovering domestic demand, albeit at a slow pace, he said.

“Chips have been the powerhouse good behind the country’s recent export boom. Korea specializes in high-tech memory chips, which are in hot demand because of the rise of artificial intelligence. But volatility in the chip cycle could slow export growth.”

Domestic demand should improve towards the end of the year since interest rates and inflation are both expected to fall.

The depreciation of the won is a concern due to a spike in import prices, but the currency should stabilize by year end coinciding with the Fed's rate cuts.

“Despite lurking project financing default risks, financial market conditions are stable. Financing risks should stay under control as long as regulators quickly and effectively respond to any unforeseen and destabilizing threats. Financial risks should ease as interest rates fall.”

U.S.-China trade feud

The escalating tension between the U.S and China pose a risk to key exports, including chips and automobiles, due to Korea’s substantial trade exposure to both countries.

Korea is in a challenging position, in his view. This is because decoupling from the Chinese market would be impractical, despite friction between its major trading partners.

China is a crucial trade partner of Korea, especially in the semiconductor and broader electronics sector, a reason why Chia considers Korea’s strategies should be about protecting its bargaining position internationally.

“Korea should play to its strengths — reinforcing its supply-chain dominance in semiconductors and other crucial industries. This would help mitigate risks and strengthen its economic position,” he said.

The economist recommended target-specific methods concerning the main opposition-controlled National Assembly passing a bill to provide blanket per capita cash handouts of 250,000 won ($185) to help revitalize the economy. About 13 trillion won will be needed.

Directing cash handouts to lower- and middle-income households, rather than everyone, would be more equitable and effective in boosting domestic demand, he said.

“The passing of the bill speaks to the urgency of addressing sluggish domestic demand.”