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[Yoo Choon-sik] Managing household debt

By Korea Herald

Published : April 22, 2024 - 05:29

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South Korea's significant household debt burden has long been recognized as one of the top risks facing the country's overall economy, positioning the nation near the top of the list among the world's major economies. Given this risk, every administration has made containing household debt one of its top economic policy goals.

The Yoon Suk Yeol administration was no exception, emphasizing the importance of containing household debt, along with government debt, since Yoon's inauguration in May 2022. The government has introduced a series of measures since its inception to tighten lending regulations for banks and financial companies and to strengthen prudential measures.

South Korea's household debt ratio to disposable income stood at 204 percent at the end of 2022, surpassing levels in higher-income countries such as the United States, Britain, and Japan, and ranking sixth-highest among members of the Organization for Economic Cooperation and Development, according to the OECD's latest data.

Nevertheless, the ratio was lower than the 210 percent set in 2021, marking its first decline in at least 14 years since the data release began in 2009, according to data compiled by the South Korean government based on OECD statistics. The reduced ratio was mainly attributable to slow economic growth and uncertain economic prospects, especially the slump in the real estate market.

Alongside the economic situation, the government's restrictive measures were also credited with contributing to the decline in the debt ratio. This is one of the few positive developments seen in the country's economy, which is otherwise struggling to regain momentum after suffering from its worst growth in modern history, excluding crisis years.

The heavy household debt burden in South Korea is not itself a huge immediate problem, especially when considering the fact that financial assets held by households far outweigh debt obligations. Net financial assets that households had in excess of financial debts amounted to 2,660 trillion won ($1.92 trillion) at the end of 2022, representing 123 percent of that year's gross domestic product, according to data from the Bank of Korea.

International organizations have stated that systemic risks facing South Korea appear manageable despite the heavy household debt burden, thanks to sizable financial buffers, adequately tight macroprudential requirements, and swift policy responses. The International Monetary Fund stated in its staff report for the 2023 Article IV Consultation that ample financial assets provide significant cushions against adverse shocks.

However, South Korean authorities need to pay close attention to the trend in household debt because high debt poses a huge potential risk to the country's economy and limits policy management by the government and the central bank. The Bank of Korea's monetary policy board always cites the household debt trend as one of the top factors to consider when making decisions on monetary policy.

While the government's policy approach toward containing household debt is widely accepted as the right choice, several aspects need to be taken into account regarding the household debt situation in South Korea, as each economic phenomenon has more than one aspect at the same time.

First, the government needs to develop and implement policy measures aimed at spurring economic growth by identifying new engines of growth and encouraging more innovative ideas, instead of focusing only on a "cut down everything" approach. Discouraging borrowing when the economy is already in a slump can only exacerbate the economic slowdown, unless such a move is accompanied by measures to boost economic growth.

It will only shrink the size of the economy, which, in turn, leads to a rise in the ratio of debt measured against GDP, unless the debt declines by a significant amount during one year, and triggers a vicious circle. Helping the economy grow should, therefore, be the utmost goal of all economic policies at all times.

Second, the government needs to refrain from relying too much on offering cheap and easier borrowing opportunities when introducing measures designed to help lower-income earners and young people because policy loan facilities introduced in recent years have been blamed for driving up overall household debt.

For instance, mortgage loans extended under such policy loan facilities rose by a whopping 14.3 percent in 2023, whereas total household mortgage loans shrank by 1.1 percent, according to data from the Bank of Korea. This lifted the ratio of mortgage loans linked to policy loan facilities to 18.6 percent of the total in 2023 from 16.1 percent in 2022, indicating that policy facilities reduced the borrowing room for ordinary households.

Third, the government needs to consider encouraging monthly house rental contracts and discouraging more common "jeonse" contracts when providing support because jeonse tenants require more money to borrow. Under the jeonse system, the renter makes a lump-sum deposit on a rental space for up to about 80 percent of the house price on the condition that the money is returned at the end of the lease term.

Total jeonse deposits were estimated at 1,058 trillion won as of the end of 2022, equal to about half of that year's GDP, according to a report published by the Korea Economic Research Institute, affiliated with the Federation of Korean Industries. As the system carries both adverse and positive effects, the government needs to gradually reduce policy loan facilities supporting jeonse renters.

Yoo Choon-sik

Yoo Choon-sik worked as the chief Korea economics correspondent at Reuters and is now a business and media strategy consultant. The views expressed here are the writer’s own. -- Ed.