The Bank of Korea grapples with the challenge of managing South Korea's exceptionally high household debt, a key factor that could hinder economic growth. Rising interest rates increase the burden of debt servicing, while the unique 'jeonse' system contributes to the problem. Economists warn that a potential credit crunch due to borrowers' inability to repay their debts could trigger deflationary pressures and a recession.
The Bank of Korea (BOK) places significant emphasis on household debt in its monetary policy decisions due to its exceptionally high levels in the country. Experts warn that unchecked household debt could severely hamper economic growth. While central banks primarily aim to maintain price stability and control inflation, the BOK grapples with the added challenge of managing this substantial debt burden.
The BOK's concern stems from the long-term negative impact that high household debt can have on economic growth. Nomura economist Park Jeongwoo explains that increased debt weakens households' spending power. Furthermore, strong demand for housing fueled by debt has distorted capital allocation, leading to investments in less productive sectors. Two key factors contributing to South Korea's high household debt are the widespread use of credit cards and the unique housing system.Prospective homeowners can purchase properties outright, but those who cannot often opt for renting. Unlike conventional rental systems, South Korean renters typically pay a large upfront deposit known as 'jeonse' or 'key money,' which can range from 50% to 80% of the property's market value. This deposit is returned at the end of the lease term. For landlords, the jeonse functions as an interest-free loan, allowing them to invest the funds. However, renters often take out loans to cover the jeonse deposit, leading to significant debt burden within the housing market.While the overall household debt-to-GDP ratio hasn't increased dramatically in recent years, rising interest rates have intensified the pressure on debt servicing, prompting concerns for both the BOK and the Korean government. Sumitomo Mitsui Banking Corporation economist Ryota Abe highlights the potential risks associated with South Korea's high household debt ratio, which stood at 91% of GDP in the second quarter of 2024, significantly higher than the 68.9% average for other advanced economies. Abe warns that a credit crunch triggered by borrowers' inability to repay their substantial debts could lead to deflationary pressures and a recession. He also points out that the debt-to-net disposable income ratio in South Korea surged to 186% in 2023 from 130% in 2008, exceeding the growth in wages and GDP. This indicates a heavy reliance on debt within the South Korean economy, particularly the household sector.Abe emphasizes that a failure within the household sector to meet its debt obligations could have catastrophic consequences for the entire financial system and the overall economy. The BOK faces a delicate balancing act: stimulating a slowing economy while managing inflation risks. Lowering interest rates could ease the burden of debt servicing but also weaken the won and potentially fuel imported inflation. Moreover, a rate cut could encourage further demand for housing, leading to an increase in outstanding household debt. Endowus' Samuel Rhee cautions that stimulating housing demand through lower interest rates could exacerbate inflationary pressures, which the BOK aims to mitigate
HOUSEHOLD DEBT SOUTH KOREA BANK OF KOREA ECONOMIC GROWTH INTEREST RATES INFLAATION
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