Big rate increase could bring big trouble

The Bank of Korea on Wednesday took a big step by raising the benchmark rate to 3 percent from the current 2.5 percent. The lifting of the key rate to the 3 percent range takes rates back to October 2012 levels. The Monetary Policy Board of the central bank has escalated the rate for nearly five consecutive months since April, except for June, in an unprecedented move. The board took the step citing the need to “curb additional inflationary pressure and growing foreign exchange risks.”

The hike in the benchmark rate could be unavoidable. As Gov. Lee Chang-yong said, the central bank cannot but lift the rate to avert economic losses despite the public’s deepening pain. If the bank leaves unattended a widening gap between Korea’s key rate and the U.S. rate, it could trigger capital flight and further devaluation of the won.

The problem is the snowballing household debt. As of June, our total household debt reached 1,869 trillion won ($1.31 trillion), or 136.6 million won per household. Those who borrowed a large amount of money from banks to buy a new home after real estate prices soared are particularly vulnerable to the rate hike. If the rate jumps by 25 basis points, home renters must pay 3.3 trillion won more as interest in total.

The annual interest rate for housing mortgages from commercial banks is expected to go over 8 percent soon, nearly tripling from a year ago. Salaried persons may have to use all the money they receive from employers to pay back their loans. Worse, as housing prices are plunging, they cannot pay back their loans even if they sell their houses. The bank estimates that 380,000 households cannot pay their debts they owe to banks.

If the situation continues, a considerable number of people may be thrown on the street after becoming delinquent. The interest burden for companies, including small merchants and mom-and-pop store owners, also will grow out of control. According to the Korea Chamber of Commerce and Industry, companies must spend additional 3.9 trillion won paying their debts if the central bank raises the key rate 0.5 percentage points.

A bigger problem is that this rate hike is not the end. The Monetary Policy Board hinted at the possibility of additional rate hikes to calm out-of-control inflation regardless of a slowed economy. That’s a warning about even tougher lives for ordinary people and small companies. The government must prepare a comprehensive policy to better respond to ominous signals across the economy while individuals and companies must thoroughly brace for the arrival of the era of high interest rates.