Park Chong-hoon currently heads the Korea Research Team at the Standard Chartered Korea.
Why household debt and housing prices matter
The Bank of Korea (BOK) is facing rising pressure from the ruling party and a government think tank to cut the base interest rate amid sluggish economic growth and moderate inflation. The BOK’s cautious approach to rate cuts reflects a deeper understanding of the complex risks facing South Korea's economy and society. While a rate cut might provide temporary economic relief, it could worsen long-standing issues such as housing inequality and household debt. The central bank’s focus on such concerns highlights the importance of addressing the underlying causes of Korea’s housing crisis before it threatens not just the country's economy but also its social cohesion and long-term stability.
Logically, the U.S. Federal Reserve's recent jumbo rate cut of 50 basis points should allow the BOK to cut rates without fearing capital outflows. Moreover, a rate cut would provide a much-needed boost to the local economy, which shrank by 0.2 percent on a quarterly basis in the second quarter of 2024. In our view, the BOK's reluctance to cut stems from rising housing prices, particularly in Seoul, and high household debt, as these issues pose long-term financial and social risks for the country, outweighing any short-term economic stimulus from a rate cut.
The prices of apartments have increased rapidly year to date as of August, particularly in Seoul's wealthiest districts; Gangnam and Seocho have seen year-on-year increases of 0.4 percent and 6 percent, respectively, well above the national average (of a 0.1 percent drop). This raises concerns about a potential asset bubble in certain areas where speculative investment and heavy borrowing could destabilize the economy if the bubble bursts, leading to a significant drop in housing prices, widespread defaults and severe damage to the financial system.
Korea’s household debt level is another critical issue, reaching 100.5 percent of GDP as of end-2023, among the top five OECD countries on this metric. Many residents have taken on large loans to buy homes, making them vulnerable to a housing market downturn or sharp interest rate hike.
While central banks tend to focus on inflation and growth, the BOK's relatively cautious stance reflects the more profound risk that stimulating the economy with a rate cut could further inflate housing prices and worsen the household debt crisis. The BOK also believes that monetary policy alone cannot fully address these problems. Government lending policies and real estate regulations significantly influence housing prices. In 2023, the government eased lending rules to support the housing market, flooding it with liquidity that pushed prices higher. Even though the BOK has maintained a 3.5 percent interest rate, speculation about future cuts has fueled market speculation, adding to the problem.
Soaring housing prices have contributed to the growing wealth gap within regions and social classes in the country. While prices in Seoul's affluent areas continue to climb, many other parts of the country have seen stagnant or declining home values. This disparity widens the wealth divide, concentrating resources in wealthy districts such as Gangnam and Seocho.
The effects of housing inequality extend beyond property ownership, in our view. Families in wealthier areas enjoy better access to high-quality education and social mobility. Education is seen as a crucial driver of success, and children from affluent neighbourhoods tend to benefit from private tutoring and better schools. This has created a cycle of privilege, whereby wealthier families can afford to secure their children's future while those in less affluent areas face significant obstacles.
The concentration of wealth in these selected regions exacerbates social inequality, undermining meritocracy and reinforcing the advantages of those already well-off. The result is a society increasingly divided along economic and regional lines, with fewer opportunities for upward mobility in less privileged regions.
The housing and debt crisis also affects the younger generation, which faces a daunting financial landscape. Many young people have chosen to delay or forgo homeownership and family formation altogether due to the high cost of housing and the burden of debt. South Korea already has one of the lowest birthrates in the world, and the rising cost of living, particularly in Seoul, is making it even harder for young couples to start families. This reluctance to have children contributes to South Korea's demographic decline. A shrinking labor force, combined with an increasing elderly population, will strain the economy and social services in the coming decades, in our view.
Amid all these factors, the BOK is caught in a difficult position. On one hand, cutting interest rates could stimulate short-term growth and counter the economic slowdown. On the other hand, doing so would exacerbate the housing bubble and worsen the household debt crisis. The central bank must also consider the risk of capital outflows if it cuts rates too aggressively, given the current interest rate gap with the U.S. This balancing act underscores the complexity of the situation and the challenges faced by the BOK in managing the economy.
Park Chong-hoon is director at Standard Chartered Bank Korea.