Household debt is at an alarmingly high level. Worse still, interest payments are growing three times as fast as disposable income. But there are few signs indicating that the debt burden will shrink anytime soon. On the contrary, interest rates are rising as inflationary pressure is increasing.
According to a recent report from the Bank of Korea, household debt, including purchases on credit, stood at 795.4 trillion won at the end of last year, up 164.7 trillion won from three years before. The debt, approaching 800 trillion won, is so huge relative to disposable household income that it is often referred to as a ticking time bomb.
The household debt service ratio ― the ratio of debt payments to disposable household income ― shows how deep in trouble the Korean economy is. The ratio was at 152.7 percent when Korea was undergoing the Greatest Recession in 2009, much higher than the U.S. ratio of 131.4 percent.
According to a report from Statistics Korea, families of two or more persons spent 933,600 won in interest payments on average last year, up 16.2 percent from a year before. On the other hand, the growth rate of household income lagged far behind ― 5.8 percent.
Another threat to household finances is coming from rising interest rates. It may be a matter of time before the central bank raises its benchmark rate for a second time this year.
The central bank raised the rate by 25 basis points to 2.75 percent in January as consumer prices rose. Pressure is mounting on the bank to raise it again this month, as the consumer price index rose to a year-on-year 27-month high of 4.5 percent last month.
One percentage point increase in interest rates for 800 trillion in household debt would amount to as much as 8.8 trillion won (it is not just 8 trillion won, because some indebted households borrow more to service their existing debts), according to a report from the Samsung Economic Research Institute.
Mortgages are a major culprit for the rise in household debt. At the end of last year, outstanding household loans from commercial banks and other financial institutions totaled 595 trillion won. According to a report from the central bank, mortgages amounted to 358 trillion won, or 60 percent of the loans.
Tightening regulations on lending money to home purchasers is undoubtedly one of the most effective ways to curb household debt. That is what the Financial Services Commission is planning to do.
The commission says that it will reverse the debt-to-income ratios next month to the level prior to the Aug. 29 easing of the mortgage guidelines. That needs to be done. But there is no guarantee that the financial watchdog will make good on its promise. Opposition is anything but negligible.
The Ministry of Land, Transportation and Maritime Affairs, the government agency responsible for housing policy, is at the forefront of a campaign against the financial watchdog’s move. It claims continued easy access to mortgages will revitalize the slumping housing market and, by doing so, help the administration solve one of its thorniest problems ― soaring housing rental costs. The ministry is assisted by proponents of a growth-first policy.
The ministry and its cohorts, however, are ignoring that debt-fueled expansions have ended in financial ruin, as witnessed in the 2008-09 global financial crisis. They may be tempted to claim, as many economic policymakers riding on a boom have done in the past, that this time will be different.
But the presidential office is urged to throw its weight behind the financial watchdog when it calls key economic policymakers to a conference on mortgage-policy coordination. How erroneous the ministry’s claim is can be learned from historical facts chronicled in “This Time Is Different: Eight Centuries of Financial Folly” by Carmen M. Reinhart and Kenneth Rogoff.