[Editorial] Fragile stability

Rise in potentially insolvent debts heightens risks of planned rate hikes

A report released by the Bank of Korea last week indicated that the country’s financial stability is at the risk of being rattled by high and rising borrowing by households and companies.

South Korea’s household debt reached a record high of 1,805.9 trillion won ($1.53 trillion) in June, up 41.2 trillion won from three months earlier. Accordingly, the ratio of household debt to disposable income also soared to an all-time high of 172 percent.

Particularly worrisome is a steep rise in debts owed by self-employed people struggling to keep themselves afloat amid the economic fallout from the pandemic and young adults earning relatively low incomes.

Loans extended to self-employed people reached 858.4 trillion won as of end-June, up 14 percent or 103 trillion won from a year earlier. Money borrowed by them from nonbanking lenders, which usually carries higher interest rates, grew at a faster pace of 20 percent over the cited period.

Debt owed by people in their 20s and 30s stood at 486 trillion won at the end of June, recording an on-year increase of 13 percent, far higher than the average rate of 8 percent for other age groups. The proportion of young adults’ borrowings in the total household debt climbed from 24 percent in 2017 to 27 percent in the second quarter of this year.

Young people have striven to take out loans to pay rents or buy homes amid skyrocketing housing prices and invest in stocks and other assets.

The central bank estimated that about 11 percent of indebted self-employed people and 7 percent of indebted young adults would be unable to pay off their debts, which amount to 77 trillion won and 33 trillion won, respectively.

What is also worrying is that the number of marginalized companies, whose annual operating profits have hovered below their debt-servicing costs for three consecutive years, continues to rise.

According to the report from the central bank, the proportion of such marginalized firms in local companies subject to external audits reached 15 percent last year, up 0.5 percentage point from a year earlier and the highest since related data began being compiled in 2010. Loans extended to the 3,465 marginalized firms in 2020 stood at 124.5 trillion won, up 9.1 trillion won from the year before.

Possible interest rate hikes down the road will increase debt-servicing costs, pushing many indebted self-employed people, young adults and faltering companies over the cliff.

The Bank of Korea is on course to tighten its easy monetary policy to rein in surging household debt and rising inflation.

In August, the central bank raised its benchmark interest rate by a quarter percentage point to 0.75 percent from a record low of 0.5 percent in place since May last year. Announcing the measure, BOK Gov. Lee Ju-yeol suggested a further rate hike could come this year or early next year.

Growing inflationary pressure as well as mounting household debt is likely to prompt central bank policymakers to raise the key rate again within this year. In August, the producer price index, an indicator of future consumer inflation, gained 0.4 percent on-month to 110.72, the highest on record. Consumer prices rose more than 2 percent for the fifth consecutive month in August, with an electricity rate hike planned for October expected to further build up inflationary pressure.

Additional rate increases seem somewhat inevitable to redress widening financial imbalances and curb rising inflation.

But careful policy coordination is needed to avoid further rate hikes pushing vulnerable households and small businesses to default on their debt, jolting the local financial market.

Market volatility could also heighten in the wake of other major economies’ adjustment of accommodative monetary policy. The US Federal Reserve is moving to start tapering its asset purchases sooner than expected while signaling it may raise its policy rate as early as next year.

During their meeting scheduled for Thursday, Finance Minister Hong Nam-ki, BOK Gov. Lee and heads of financial regulatory authorities should fine-tune policies to address the looming risks to the economy.

By Korea Herald(koreaherald@heraldcorp.com)