Korea's next asset bubble?

By Peter S. Kim

Despite the prolonged pandemic, the South Korean stock market is at an all-time high on the back of frenzied buying from retail investors. The Korean government's ultra-easy monetary policy, coupled with its seemingly unlimited stimulus spending, are fueling fearless investor sentiment, leading to concerns of a dangerous asset bubble.

The desperation of Korean savers to escape the near-zero returns of bank deposit accounts has sparked the rush into riskier assets like equities. The search for yields is now turning into irreverent greed, typified by spectacular gains in cryptocurrencies and stocks like Tesla from the U.S.

While retail rushes into the stock market are being seen in many parts of the world, the Korean version is complicated by the political motivation of the government to keep the bull market sustained for everyday retail investors. On the other hand, the Korean government seeks to suppress its domestic property market, which is not far behind in terms of its bubble features.

The property market is likely the most crucial election issue, and may decide the next Korean president. Since being elected into office over four years ago, taming the residential property market has been a top policy priority for the Moon Jae-in administration. Residential property takes up over 70 percent of Korea's household assets, making it a critical economic and political issue.

Recently the Moon administration announced a set of property market clampdown measures to stop the soaring of property prices ― its 26th during the past four years. Understandably, there is an air of desperation surrounding the announcement, as the property prices continue to rise despite repeated rounds of punitive taxation initiatives.

In a joint press briefing, the Ministry of Economy and Finance and the Ministry of Land, Infrastructure and Transport warned of a possible crash in property prices reminiscent of the financial crisis of 1997. They emphasized the need to halt property speculation, which hurts the working class' prospects of owning a home. The latest warning is highly unusual considering the government's efforts to support the economy via fiscal and monetary stimulus measures.

With the COVID-19 pandemic looking like it will be extended for longer than first hoped, a rising property market would be a convenient way to support domestic consumption, with its positive wealth effect. Therefore, talking the property market down while the economy is struggling would seem counter-intuitive.

I postulate that Korea's central bank, the Bank of Korea (BOK), could diverge from its previous stance of following the U.S. Federal Reserve by pre-empting rate hikes early. This postulation is due to concerns over Korea's household debt ― one of the highest globally ― causing many analysts to predict it will be the next financial bomb to go off.

My analysis reveals that most of the rise in household debt is due to borrowing by individuals to finance home purchases. Therefore, the household debt issue will be manageable as long as the property market is stable. Besides the household debt concerns, political sensitivity due to the widening income gap, rooted in the rising property prices, is a bigger reason for the government's hawkish stance on Korean housing.

While the increasing prices surrounding the metropolitan area are not unique to Korea, the sensitivity around property prices and their importance for politicians means that the independence of the central bank could come under a cloud. Nevertheless, concerns of a property market crash leading to a banking crisis are premature.

Even though most of the rise in household debt is linked closely to residential property, the Korean banks are safely provisioned with a minimum of 50 percent value. Also, the rise in property prices is centered in select areas of Korea ― particularly southern Seoul's Gangnam area. For the rest of the nation, the increase in housing prices remains modest, keeping the exposure of the speculative areas from getting large enough to pose a risk to the financial system.

Ultimately, the effective way to stop the rise of property prices is through tight monetary policy. With the BOK guiding a possible rate hike in the coming months, we could enter a period of instability in residential prices. But for there to be a significant downside to prices, it will require several aggressive rate hikes.

The weak economic conditions and the latest surge in COVID-19 cases make that scenario unlikely for now. But another year of rising prices could change the positive outlook rather quickly. In the meantime, we should expect more frustration from home seekers looking for affordable prices.

Peter S. Kim (peter.kim@kbfg.com) is a managing director at KB Financial Group.