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[Editorial] Rising debt

Unchecked household borrowing risks precipitating economic downturn

Concerns have been raised that an accelerated increase in household debt will dampen domestic consumption, pushing the country’s already struggling economy further into a downturn.

According to recent data from the Bank of Korea, outstanding household debt grew by 15.4 trillion won ($12.7 billion) from three months earlier to 146.7 trillion won in the April-June period of the year, compared with an increase of 2.9 trillion won in the previous quarter. In July, household debt rose by 5.8 trillion won, surpassing the monthly hike for the prior two months.

If the current pace continues, household borrowing from banks and nonbank lenders is expected to exceed 1,500 trillion won in the coming months.

The swelling of household debt is worrisome, particularly at a time of slowing growth. Increased household debt could dampen domestic spending, further weighing on the country’s economy, which has been troubled with weakening exports and investments.

South Korea’s exports for July fell 11 percent from a year earlier due mainly to intensifying trade tensions between the US and China and a drop in the price of semiconductors, extending the streak of on-year decline to eight months.

Facility investments in Asia’s fourth-largest economy have shrunken for four consecutive quarters since the April-June period of 2018.

Domestic consumption has helped shore up the economy amid growing external uncertainties. But a steep increase in household debt is set to suppress private consumption, with indebted households tightening their purse strings while struggling to service debts.

The BOK projects that the country’s private consumption will grow 2.3 percent on-year in 2019, down from 2.8 percent last year. The growth rate is expected to decelerate further, if household debt continues to rise at a steep pace.

Private consumption increased 0.7 percent on-quarter in the April-June period of the year, compared with a 2.5 percent rise in government spending during the same period.

Sluggish domestic demand coupled with declining outbound shipments would push local companies to reduce investments and output. A simultaneous reduction in domestic spending, exports and investments would drag the economy deeper into a low-growth rut.

The BOK last month revised down its 2019 growth forecast for the country’s economy to 2.2 percent from its previous prediction of 2.5 percent three months earlier. The trimmed figure still looks rosy, with most economic institutions at home and abroad projecting South Korea’s economy will expand less than 2 percent this year.

Rising household debt poses a dilemma for the BOK regarding additional interest rate cuts.

The central bank, which lowered its key policy rate by 0.25 percentage point to 1.5 percent last month, would be under pressure to cut the rate further, if the economy remained exposed to growing downside risks at home and abroad. But additional rate cuts would risk heightening financial instability by accelerating the increase in household debt.

What is most concerning is the possibility that the growing burden of debt servicing will be accompanied by asset devaluation.

Government officials dismiss that possibility, noting that the country’s economic fundamentals are strong enough to prevent the economy from being hit by significant deflation anytime soon.

But the value of assets such as properties and stocks could tumble if households were pressed into selling assets to repay debts due to reduced income amid an economic slump. Low prices would have the effect of pushing up real interest rates, increasing the debt servicing burden on households.

If asset devaluation were to accompany the hollowing out of manufacturing industries, as many experts worry, the country’s economy could be drawn into a long-term recession that resembles Japan’s “two lost decades” from the early 1990s. Worryingly, the country’s manufacturing firms have been moving production abroad to avoid rising labor costs and persistent regulatory restrictions at home.

Measures need to be taken to manage household debt at an appropriate level and settle the problem of marginalized households that cannot afford to repay debts.

The government should also refrain from implementing policies designed to push down asset values, such as placing a cap on the prices of reconstructed apartments.

At the same time, more consideration should be given to how to bolster the local stock market, which has shown the worst performance among major economies so far this year. The fundamental way would be to help companies make more investments and earn more profit by lifting barriers to new business and reducing tax burdens.