Bracing for the repercussions

The government has embarked on financial tightening to brace for a possible interest rate hike in the United States. Starting March 26, consumer loan regulations will tighten through a tougher criteria on debt-to-service, rent-to-interest, and loan-to-interest ratios. Credit standards have become tightened to rein in further growth in consumer loans against rising interest rates.

By the end of December, Korea’s household debt had topped 1,450 trillion won ($1.36 trillion). Loans to self-employed individuals surpassed 500 trillion won. The question is how much of these loans can be manageable when interest rates go higher. At the U.S. Federal Reserve’s policy rate meeting on March 20 and 21, The board is likely to deliver another a 25 basis-point hike to place the fed fund rate at 1.50 to 1.75 percent and above the Korean benchmark rate of 1.50 percent. Even if the Bank of Korea does not match the hike in its policy meeting in April, it inevitably would have to push up the key interest rate to keep the gap with the market yields and U.S. rates marginal.

South Korea is in for a serious hangover from an ultra-loose and low interest rate binge. The latest Bank of International Settlements report showed South Korea’s household debt share against its gross domestic product (GDP) at among the highest levels in the world. By the third quarter last year, the ratio hit 94.4 percent by rising 14 consecutive quarters from the second quarter of 2014. Korea’s rank in household debt proportion to GDP rose to seventh from 12th.

When liquidity is squeezed and lending cost rises, households with stagnant incomes could stop spending. Mortgage loan rates have already shot up 5 percent. Added housing costs would discourage middle-income class from spending. Mom-and-pop store owners and small merchants will be pained further in addition to the increased labor cost from a hike in minimum wage. Banks decided to toughen scrutiny on borrowers in restaurant, lodging, wholesale and retail sales and real estate rental businesses by categorizing them as risky credit.

In 2002, The Economist warned of another financial crisis if the credit card bubble burst in Korea. A year later, it became a reality. Over 3 million people became credit-delinquent after the credit card binge came to an end. Korea’s economy grew in the 2 percent range in 2003 as a result.

Hyundai Research Institute has kept this year’s growth estimate at 2.8 percent due to slowing exports and capital investment. The government must do its best to strengthen the economy to generate growth, jobs and incomes so that debtors can continue to meet their obligations and afford to spend.

JoongAng Ilbo, March 19, Page 30