Snowballing Korea Household Debt – Big Challenge for Economy

By Park Sae-jin Posted : November 25, 2015, 13:42 Updated : November 25, 2015, 13:42

South Korea’s household debt has surged to hit a record high, posing a serious threat to financial stability in Asia’s fourth-biggest economy.

Household credit - borrowings from financial firms and purchases on credit - rose to an outstanding 1,166.04 trillion won ($1.01 trillion) at the end of September from 1,131.54 trillion won at the end of June, the Bank of Korea data showed

In just three months, household debt and credit card spending grew 3 percent, or 34.5 trillion won, the biggest quarterly increase since data began being compiled in its current form in 2002.

The mounting household debt emerges as one of biggest risk factors facing the Korean economy, as it braces for an imminent U.S. rate hike and economic repercussions from the Nov 13 attacks in Paris.

“Despite the recent terrorist attacks in Paris, there is a high possibility that the (U.S. Federal Reserve) will raise the base rate in December,” Bank of Korea governor Lee Ju-yeol said on Nov 17 in a speech at a Korea Chamber of Commerce and Industry meeting in Seoul.

Analysts predict the Bank of Korea will keep its base rate at record low of 1.5 percent next month despite the snowballing household debt and the likelihood a U.S. hike.

A robust increase in household credit is a positive sign for economic growth but at the same time a source of concern for policymakers in South Korea because credit has been growing much faster than the broader economy.

President Park Geun-hye has also expressed concerns about the possible negative effects from a U.S. rate hike.

During her speech in an economy-related session at the Group of 20 forum in Turkey last week, Park said that “normalization (hikes) of interest rates in developed countries should be conducted on a gradual basis in consideration of impacts on the global economy.”

Last Friday, Joon-Ho Hahm, a member of the Bank of Korea's Monetary Policy Board, warned emerging market economies could suffer considerably when the Federal Reserve starts raising interest rates.

Hahm told the San Francisco Federal Reserve Bank's Asian Economic Policy Conference that South Korea has taken steps to prepare for higher U.S. interest rates, but said a Fed rate hike will still present a "crucial policy challenge" for his central bank.

"The latent risk and potential impacts associated with the upcoming U.S. interest rate hike could be large in EMEs (emerging market economies), and Korea would not be exempt," Hahm said.

The Fed has put markets on notice that it may raise short-term rates in December after keeping them near zero for seven years.

A rise in the U.S. benchmark interest rate could trigger outflows of short-term capital, "giving rise to significant negative externalities for our real economy," Hahm said. Financial stability could also be threatened because the Bank of Korea's current low-interest rate has helped boost household debt.

Currently, the Bank of Korea judges it likely that banks could absorb the shock that a sudden interest-rate rise and a drop in housing prices could generate, Hahm said.

But the Bank of Korea has been working to incorporate financial stability concerns into its monetary policies in order to make sure the economy is properly buffered, he said.

Thomas Byrne, president of the New York-based non-profit Korea Society, said in a breakfast meeting on Tuesday in Seoul that U.S. rate hike will have effects on every economy in the world,"

But Byrne, a former analyst for Moody’s, added South Korea is strong enough to get over the headwinds from the U.S.

"Korea is in a pretty good position to stand this. (Korea) has monetary policy space, external vulnerability has been greatly reduced and Korean corporations have well contained the level of external debts," said Byrne, a former analyst for Moody's.

"So I am not expecting any major dislocation to the Korean economy once the U.S. begins the process of liftoff."

"(Rising household debt) is because of the low-interest rate and also because of macro-prudential easing," he said. "When the interest rate starts rising, Korean households will borrow less and it could be a silver lining in the clouds."

According to a report by the Bank for International Settlements in September, Korea ranked the highest among 14 emerging economies for its household debt-to-GDP ratio last year, which was 84 percent. This was not only higher than the 30 percent average of the emerging markets but also 11 percentage points higher than the 73 percent average of 26 developed countries.


By Alex Lee
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