The loophole of household debt

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The loophole of household debt

A disproportionately heavy load of household debt can undermine Korean economy’s structural fundamentals. Too big a household debt can no doubt generate a financial crisis in the short-term, and in the longer run erode growth potential and prolong economic slowdown, according to the Bank of Korea’s latest study on Korean consumer and public debt.

Household debt, if left unrestrained at its current pace, will slow the economy and accelerate a slump. Uncontrollable individual debt would naturally dampen consumer spending and put the economy in a liquidity trap or prolonged depression.

Our household debt reached 912.9 trillion won ($799.4 billion) at the end of last year, up 7.8 percent from the previous year. The growth of the household debt has slightly lessened from a 9 percent annual gain since 2005, but nevertheless is still dangerously fast. The central bank has downplayed any risk of household debt causing chain insolvencies at financial institutions across the country even if a global crisis of 2008’s scale breaks out now. So far, Korea’s household debt has not reached a dangerous level strong enough to trigger a major catastrophe in our economy.

But the “quality” of household debt is nevertheless exacerbating due to sharp increases in borrowings particularly by consumers with low income and credit ratings from non-banking lenders. The share of new loans by consumers with an annual income of less than 30 million won rose last year, while the share of new loans by consumers with an annual income of more than 30 million won fell. In other words, the lower-income bracket is seeking more debt and that leads to a noticeable increase in deferred payment in loans and interest rates.

The bigger problem is that low-income families with debt exceeding their affordability means that they have less to spend due to their burden to repay the principal and interest. Dampened consumption would eventually slow economic recovery and even with greater income, consumers would be too busy paying off debt to have any left to spend.

If the government does nothing about it, household debt would pose as the biggest stumbling block to economic growth. Just because it does not pose an immediate danger to the economy, household debt should not be taken lightly. Authorities should study and figure out ways to help low-income families increase their income to pay off their growing debt with less repayment burden and tame the overall household debt size.

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