By Kim Jae-kyoung
The Korean government should come up with macroprudential measures to curb household debt to prevent the excessively rising debt from becoming a source of financial instability, a number of global economists warn.
They said more and more households with lower income are becoming susceptible to higher interest rates.
“It should be mindful that a group of borrowers with poor credit ratings and low income as well as self-employed borrowers are vulnerable to unfavorable interest rates and income shocks,” said Sumio Ishikawa, lead economist for Korea at the ASEAN+3 Macroeconomic Research Office (AMRO).
Established in 2011 in Singapore by 10 ASEAN member states and Korea, Japan and China, AMRO is Asia’s regional macroeconomic surveillance unit. It is the Asian equivalent of the International Monetary Fund (IMF).
“Although a rise in debt might be inevitable in growing economies, the credit-to-GDP ratio needs to be closely monitored with more attention to the non-banking sector,” he said. “The government should ensure that the debt level is sustainable.”
The warning came as the nation’s household debt nears 1,400 trillion won ($1.23 trillion), which is around 93 percent of the country’s 2015 GDP.
What is of concern is that speculators are driving the sharp rise in household debt and real estate prices in and around Seoul.
“The cause of the ballooning household debt problem is speculation in the real estate market,” said Sohn Sung-won, professor of economics at California State University.
Amid growing concerns of mortgages becoming systematic financial distress, Finance Minister Kim Dong-yeon has vowed to crack down on speculative investment by employing all possible measures.
Stijn Van Nieuwerburgh, a professor of real estate finance at New York University’s Stern School, indicates Korea has fallen into a vicious cycle of low interest and high housing prices.
“Low interest rates may make mortgage debts attractive and can fuel a housing boom,” he said.
“Conversely, high housing prices require ever larger mortgage balances, even if the ratio of loan to property value stays constant. So growth in property prices and mortgage debt go hand in hand.
The economists stressed the importance of addressing high household debt effectively to minimize adverse impacts on growth and financial markets.
In that regard, to slow the growth of household debt, they recommend the government opt for macroprudential measures rather than monetary policy by hiking interest rates.
“Household debt is partially the reason why we think the Bank of Korea (BOK) will drag its feet to hike rates until next year at least,” said Alicia Garcia-Herrero, chief Asia-Pacific economist at Natixis.
“The government should take measures to tackle this issue, including affordable housing policies and further tightening of macroprudential measures, such as down payment requirements and banks’ loan-to-deposit ratios.”
BOK Governor Lee Ju-yeol recently hinted at a tightening of monetary policy, saying, “There is a need to adjust the extent of monetary easing if economic conditions show a marked improvement.”
The likelihood of a BOK rate hike is further growing after the Fed raised its interest rate by 25 basis points to a range of 1 percent to 1.25 percent a week ago.
Sohn said the central bank raising the interest rate would simply make the situation worse.
“It is important to understand that this kind of microeconomic problem should not be addressed by the BOK or monetary policy,” he said.
“The BOK should focus on the big picture, namely economic growth and disinflation, not microeconomic factors. Macroprudential government regulations at financial institutions should be more actively used to discourage speculation.”
He recommends Korea take a cue from the United States where regulatory authorities such as the Federal Reserve use supervision and regulation to discourage banks from relying on real estate loans too much.
In the U.S., the amount of real estate loans is limited by the amount of a bank’s capital, meaning U.S. banks are limited on how much real estate loans they can put in the books as a percent of capital.