Korea's debt advantage

• Published Jun 3, 2015 5:11 PM KST
• Updated Jun 3, 2015 5:11 PM KST

By John Burton

Good news sometimes is obscured. While there are many worries about the shape of the Korean economy from slowing growth to growing inequality, there is at least one bright spot.

While much attention has been focused on Korea’s mushrooming household debt, the government’s financial strength positively shines when compared with other countries around the world from Japan to Greece.

Policymakers should be commended for learning the lessons of the past, particularly the near-death experience of the 1997 financial crisis, in protecting Korea from global financial turmoil.

Unlike many other countries, Korea has the financial firepower to respond rapidly to domestic risks and external shocks. The government has run a budget surplus since 2010, while its debt burden amounts to 36 percent of gross domestic product (GDP), one of the lowest rates among the rich OECD countries. Compare that with the Japanese government debt of around 225 percent of GDP.

The result is that the Korean government’s financing costs are relatively low. The country has also weaned itself from dependence on external creditors as the domestic capital market has grown.

It was Korea’s reliance on foreign credit that was a main cause of the 1997 crisis when overseas lenders suddenly decided to withdraw their funds to local corporate and bank borrowers as they panicked after financial turmoil erupted in Southeast Asia.

The 2008 global financial crisis reinforced this message of vulnerability to external funding, although Korea quickly bounced back from the turbulence that was hitting many markets.

Large amounts of short-term external debt are particularly dangerous as highlighted in the 1997 crisis. While borrowers can plan ahead with long-term loans, short-term loans can be quickly pulled and thus expose borrowers to a cash squeeze if no new funds can be raised.

Korean banks and companies have worked hard to reduce their short-term debt exposure from $190 billion in 2008 to $115 billion at the end of last year.

In addition, Korea’s strong current account surplus is another form of protection against possible volatile capital flows if the U.S. starts raising interest rates soon since it has ended its policy of qualitative easing. There are concerns that money will flow from overseas, including Korea, to the U.S. once the Fed hikes rates.

The current account surplus has grown due to falling oil prices since Korea is a big oil importer. At the same time, lower oil prices are starting to revive the struggling economies of some of Korea’s biggest overseas customers, such as in Europe, which bodes well for exports.

Moreover, there is less worry about the government needing to bail out or take over troubled companies as it was forced to do in the wake of the 1997 financial crisis. Corporate debt levels have fallen drastically since then.

Korea’s strong financial position could be further improved if the government continues with its efforts to reduce the heavy debt burdens of state-affiliated companies, such as property developer Korea Land and Housing Corporation and electricity supplier KEPCO. These companies pose potentially large contingent liabilities on the state balance sheet.

So what could spoil this enviable picture of financial robustness? There are three possible threats.

One is the household debt situation. If household debt continues to rise and economic conditions deteriorate, the government might ultimately be forced to support the banks against a rise in defaults, a move that would sap government finances.

The government is working to prevent this scenario from happening. It is pushing for the adoption of fixed-rate mortgages rather than the variable rate ones that now dominate the housing lending market. The problem with the latter is that as interest rates increase, it pushes the debt servicing costs for households higher and thus the possibility of more defaults.

The second threat comes from Korea’s demographic time bomb as the population rapidly ages. An older population usually results in declining economic growth unless ways are found to increase productivity, already a key challenge for Korea. In addition, the government will be forced to increase social spending in the future to take care of the elderly.

Finally, and potentially the most damaging, would be a sudden upheaval or collapse in North Korea. Signs of what appear to be factional infighting in Pyongyang between the older elite of officials and those surrounding the “young marshal” Kim Jong-un may be bringing that prospect closer than everyone what have expected even a year ago. The enormous costs of restructuring North Korea would vastly strain South Korea’s finances, at least in the short to medium term.

So while the government has made great progress in cleaning up its financial house since the 1997 crisis, it is not by any means out of the woods.

John Burton, a former Korea correspondent for the Financial Times, is now a Seoul-based independent journalist and media consultant. He can be reached at john.burton@insightcomms.com.