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[Viewpoint] Household debt threatens recovery

It’s been a hard journey, but Korea has escaped the dark tunnel without too much trouble. The economy has endured waves of global economic crisis and is recovering most rapidly among OECD members. With forecasted growth of about 5 percent next year, Korea is contemplating when to raise interest rates.

Korea got over the crisis so fast because government and banking finances were relatively healthy. Korea could afford to lower interest rates considerably. In fact, the Bank of Korea lowered the key rate six times for a total cut of 3.23 percent from 5.25 percent after the financial crisis. Major developed countries had little room for interest rate cuts since their rates were already zero or very low.

Korea also learned a lesson from the foreign currency crisis a decade ago. The government promptly and drastically injected capital. Investors, who experienced increased asset values after the last crisis, continued to buy stocks.

Korea was lucky as well. The fall of the won boosted exports, and Korea was chosen to host the G-20 summit meeting.

Yet, next year poses challenges. While the government extinguished the fire with cash, civilian investment is not recovering as easily. Also, the economy is expected to suffer from high oil prices, high won values and high interest rates. The government needs to carefully manage economic policies to keep the fires of market recovery burning.

Most of all, we need to understand the main risks to the Korean economy. One of the biggest concerns is rapidly growing household debt. As of the end of September, total household debt was 712.8 trillion won ($608.7 billion), exceeding 700 trillion won for the first time. Despite the economic slump, household debt increased by 15 trillion won in only three years, mostly in housing mortgages. In the United States, Japan and Spain, household debt is shrinking or remains unchanged.

As household debt grows, economic growth could suffer. A real estate bubble, insolvency in household and financial institutions and a drop in household savings are all factors to consider. Meanwhile, disposable income is shrinking as a result of the financial crisis. Household income is not likely to increase next year.

At the same time, we need an exit strategy as we prepare for inflation and a way to deal with the government’s growing deficit. Bank of Korea Governor Lee Seong-tae recently suggested the possibility of an interest rate increase, saying “the BOK will continue to think about the timing based on the market and prices every month.”

Moreover, household debt is mostly related to real estate prices. In the United States, real estate prices have fallen by about 30 percent since the financial crisis, but prices in Korea have not been adjusted yet. Some believe real estate prices will inevitably fall as the population shrinks. If real estate prices drop drastically with the increase of interest rates, households with large debt will be struck fatally.

In the case of a double-dip recession resulting from a commercial real estate price bust in the United States, the crisis will grow out of control. We desperately need pre-emptive financial and housing policies for stable household debt management.

To keep households solvent, financial institutions need to manage risk. They need to keep the money flow tight, especially if housing mortgages increase drastically or house prices rise suddenly. And a household debt workout program should be implemented. The Credit Welfare Commission and the Smile Microcredit Bank focus on low-income families, but middle-class workout programs should also be prepared. Banks contributed to increasing household debt by competing to issue loans. They should also be responsible for helping families manage debt.

Household loans should be steered toward fixed rate and long-term loans. Since floating rate loans make up 70 to 80 percent of all loans, uncertainty following interest rate changes is inevitable. Banks should not be allowed to profit by collecting higher rates for housing mortgages. The Korea Housing Finance Corporation’s bogeumjari loan limits the grace period to three years and has a competitive edge in terms of interest rates, but it poses a considerable burden to repay the principal.

Moreover, credit card companies’ reckless credit card issuance should not be left uncontrolled. As SKT and KT move into the credit card business, competition will only become more intense. Many people are likely to bump up the amount of debt through reckless balance transfers.

It is urgent to stimulate real estate sales to help debt-ridden households. The tax system needs to be revised so that transaction-related taxes such as the acquisition tax and registration tax are lowered while possession-related taxes such as property taxes are raised.

These days, builders are struggling with unsold homes and buyers who fail to make payments. Buyers can make payments and move into new homes when they sell their current residences, but doing that is hard.

Moreover, households need to manage risk prudently. We should not forget that interest rates rose to 20 percent right after the foreign currency crisis, resulting in many bankrupt households.

Next year should be a year of household restructuring.

*The writer is the senior business news editor of the JoongAng Ilbo.

by Park Eui-joon