Deleveraging takes a toll

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Deleveraging takes a toll


As the Bank of Korea prepares to update its estimate for economic growth today, a recent study by the Korea Institute of Industrial Economics and Trade showed that household cutbacks on spending due to continuously growing household debt may undermine any hope of robust growth.

On top of the falloff in consumer spending that followed the sinking of the Sewol ferry in mid-April, the appreciation of the won against the U.S. dollar is also expected to lower the central bank’s outlook for this year’s economic growth. There is already a growing consensus in the financial market that the central bank will be scaling back its growth projection from the earlier 4 percent to 3.8 percent.

Newly appointed Finance Minister Choi Kyung-hwan has been stressing the need for a supplementary budget to stimulate the economy and there is already growing pressure on the central bank to lower interest rates to complement the new Finance Minister’s stimulus campaign.

Amid all these concerns, the study by KIET focuses on the household debt situation as a troubling factor in the economy. But the study noted that the worry is not that the loans will go bad and damage the financial sector. On the contrary, it says the problem lies in cutbacks by households concentrating on repaying their debts while household income growth stalls.

According to the Bank of Korea, at the end of March overall household debt including credit card spending totaled 1,024.8 trillion won ($1.01 billion), an all time high.

The study noted that households have actually been improving their debt situations by paying off their debts and increasing savings.

But as households focus on repaying debts, their spending has fallen and this is affecting the domestic economy.

In fact, households’ annual income-to-debt levels have been improving. In 2010 the level was 22.7 percent but last year, it grew to 25.9 percent. This year it is expected to rise to 26.6 percent, indicating that more households will have more money to spend.

However, average spending has fallen. Households’ spending-to-disposable-income ratio in 2011 was 76.7 percent. This fell to 73.5 percent last year.

As a result, the ratio of households whose spending exceeds their income fell from 26.4 percent in 2011 to 22.5 percent last year, indicating there are more households cutting back on spending.

“Households have been repaying their debts and increasing their savings in order to reduce their overall household debt,” said Chung In-hwan, who wrote the study. “However, on the flip side, spending has been falling.”

The study showed that growth in consumer spending, although improved last year, still remains below the nation’s economic growth.

It noted that before the global financial crisis of late 2008, geographical areas that had higher debt compared to their incomes saw higher spending growth. But after the crisis it is these areas where consumers have sharply reduced their spending.

“In the past, debts eased the budget restraints in households, which resulted in spending,” Chung said. “But in recent years, the burden of repaying debt principal has increased and this resulted in constraints on households making purchases,”

Analysts say the reason many household have to cut spending to pay off debt is because their incomes have been frozen as the economy stalls and alternative revenue sources such as making money on real estate have dried up too.

Low interest rates have kept savings from generating extra income for households. Even the stock market has been disappointing.

The report said the situation could get worse if households start deleveraging at a more intense rate.

“There is a need for policies that would both manage the overall household debt situation while improving household incomes,” said Chung. “There is an urgent need to create supportive policies that would generate income for the more vulnerable lower income households.”

Earlier this week, the newly appointed Finance Minister noted that while the overall debt size is a major concern, it has been growing at a steady rate. He added that the Finance Ministry will focus on finding solutions that would improve the disposal income situation.


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