Watch the mounting household debt

The test continues for the BOK.

Chung Un-chanThe author, a former president of Seoul National University, is the chairman of the Korea Institute for Shared Growth. Money management or finance enables individuals, companies and public corporations to look beyond the day-to-day perspective and plan for the future. But too much of a good thing can be bad, and the same goes for finance.

South Korea is overly leveraged. According to the Bank for International Settlements (BIS), the private sector debt against Korea’s GDP reached 222.7 percent at the end of 2023, the fourth highest among 38 OECD members. The debt scale can differ by historical and cultural features. But Korea’s debt stands out because its debt growth against the pre-pandemic period had been the fastest.

The debt load of the other three countries — Switzerland, Sweden and Norway — with greater private debt-to-GDP ratios than Korea has plateaued or decreased over the last four years. The U.S. ratio declined by 3.3 percentage points. But Korea’s private-sector debt ratio surged by a staggering 26.5 percentage points over the last four years.

A spike in debt over a short period can catalyze insolvencies if earning levels cannot meet obligations and lead up to a financial crisis. The bulky growth in household debt poses the biggest concern. The debt growth also had been the fastest in Korea among OECD countries for the last four years. The pace accelerated this year. Household lending by banks that fell in 2022 increased by 37 trillion won ($27.8 billion) in 2023 and another 25.9 trillion as of July this year. The outstanding loan balance has stretched to 1,120.8 trillion won.

The bulge in household debt owes largely to the Bank of Korea (BOK) and government policies. The BOK’s premature freeze in the benchmark rate sent the wrong message to turn households back to leveraged financing. The Korean central bank made its last hike in January 2023 and stayed put despite the U.S. counterpart’s hikes by 2 percentage points since.

The government has been equally lenient. The financial authorities pledged to contain household debt and announced the tougher debt-service ratio rule. But their actions had opposite results. It offered cheap loan subsidies to help borrowers shift to lower-rate loans. Authorities hampered banks from raising loan rates through administrative guidelines in the name of lessening the side effects from high interest rates. Bank lending to households added 5 trillion won monthly from April, debunking the government pledge to cap the gains in household debt rate within the rise in the nominal GDP.

A rate hike is aimed to dampen borrowing demand to contain excess debt growth and steer deleveraging to clear out bad debt. When increasing debt dues are late because they can’t be covered by earnings, the risk translates to the financial sector and the economy. The BOK therefore shares the liability for exciting household debt growth that can bring about financial instability, as it sat on its hands too long.

The BOK’s rate inaction also has not helped price stability, which is the core of the central bank’s role. The record 2 percent gap between Korean and U.S. rates fueled the U.S. dollar’s strength against the local currency in the first half of 2023. The Korean won’s depreciation fueled inflation because imports of oil and other commodities essential to run the economy became pricier.

If the government wants to prevent financial insecurity and worries about future growth, it must hasten to come up with measures to roll back household debt. The government has been deferring the deleveraging policy and instead resorting to makeshift relief actions for households and the self-employed on the brink of bankruptcy. The future is at stake because all eyes are on the present. If we do not do something about the “borrowing society” — to borrow the title of Hyun Jin-geon’s 1921 novel “Drinking Society” — the wretchedness of households will perpetuate.

The test continues for the BOK. If it emulates the expected U.S. Fed action of lowering its rate target in September while over-leveraging remains a serious issue in Korea unlike the United States, the central bank can exacerbate the side effects. I pray it will be wiser.

Translation by the Korea JoongAng Daily staff.