The government has unveiled a set of measures aimed at curbing the country’s large household debt, which is one of the biggest internal risk factors that might trigger a crisis in the Korean economy. Here is Professor Choi Bae-geun from the Department of Economics at Konkuk University to analyze what the Korean government plans to do in order to address this difficult problem and how effective the new measures will be. First, Professor Choi explains the comprehensive household debt measures that the government announced on October 24.
The goal of the new measures is to control the aggregate amount of the debt by reducing household debt gradually, improving the quality of the debt, and curbing speculative demand in the real estate market. To achieve the stated goal, the government will introduce two key measures—a new debt to income or DTI ratio requirement, and a debt service ratio or DSR. First, from January next year, loan limits will include the principal of a borrower’s existing houses. That means those with over two mortgage loans will find it difficult to take out additional loans. Secondly, lenders will adopt a new mortgage restriction rule called DSR in the second half of next year. Under the DSR rule, banks will reflect an index that divides principal and interest payments of all loans, including overdrafts, by annual income when calculating the amount of loans that a borrower can receive. A higher DSR ratio means a loan seeker has lower repayment capability, and those with higher ratios will be restricted from getting loans.
The ultimate goal of the new measures is to steer rising household debt into a soft landing. For that purpose, the government has decided to toughen loan limits. With the new DTI rule, mortgage regulations will be strengthened for owners of multiple homes, who have more than two pending mortgages, making it difficult for them to receive new loans. An even stricter lending rule known as DSR will be introduced in phases, starting in the latter half of next year. Under this system, a lender will set loan limits after looking into the overall burden of principal and interest payments of not only mortgage loans but credit-based ones as well. If the system is implemented, the amount of loans taken out by multiple homeowners will be less than half that of the current level. While it will be almost impossible for people who own multiple homes to take out additional loans from next year, the government will provide more support to low-income borrowers who find it hard to pay back their debts.
The government wrote off the small-sum debts of less than 10 million won that have been overdue for over 10 years. The amount totals 1.9 trillion won, or 1.7 billion US dollars. For borrowers who lost a job or closed their business, the government will delay repayments of the debt principal by up to three years. There has been criticism that microcredit programs for low-income earners are rather inadequate. The government is considering expanding these programs.
The government unveiled its support plan tailored to those who are vulnerable to household debt risks, in order to prevent high-risk borrowers from being overdue on payments for a long period of time. In brief, the government will employ both regulations and financial support in carrying out its new measures in an effort to reduce snowballing household debt, which is nearing a dangerous level.
It’s been nearly ten years since the global financial crisis occurred, and mounting debt has been cited as one of the factors that might cause another crisis. Foreign analysts are concerned about rising debt in Asia, especially in China and in South Korea. Korea’s household debt is growing fast. The ratio of household debt to net disposable income stood at nearly 179 percent in 2016, well above the average of 135 percent for the Organization for Economic Cooperation and Development, or OECD. Also, Korea’s ratio of household debt against nominal gross domestic product or GDP was almost 96 percent, 26 percentage points higher than the OECD average of 70 percent. If a debt crisis erupts, the economy will inevitably be mired in a long recession because it will take considerable time to adjust the debt. That’s why the government is focusing on bringing down the aggregate debt.
South Korea’s household debt saw double-digit growth in 2015 and 2016. As of the end of June this year, household debt reached 1,388 trillion won or about 1.22 trillion US dollars, but it is forecast to surpass 1,450 trillion won by the year’s end since it has shown a double-digit growth so far this year. The government believes that the rate of growth is too fast, even compared to the economic growth rate or the inflation rate. According to financial authorities, 320-thousand households with 94 trillion won in debt are having a hard time paying back the money, while loans worth 100 trillion won are already considered irredeemable. To cope with the situation, the government has come up with measures to prevent short-term risks, such as insolvency of vulnerable groups, and to manage the debt in a stable way and improve the debt structure in the mid-and long-term. However, experts are wondering whether the measures will help resolve the household debt problem.
I think the measures will only have a limited effect. The government says it will keep the annual household debt increase rate in the 8-percent range. But the figure is still high, compared to the income growth rate. The introduction of the new DTI rule will certainly prove effective in reining in demand for new loans from multiple homeowners. But the regulation will be limited to particular regions, such as the Seoul metropolitan area and speculative investment regions. In other words, the rule will not be applied nationwide, in consideration of potential negative effects on the nation’s real estate market. I think the effect of the household measures will be limited, as long as the government is concerned about the real estate market slump.
The new measures can be viewed as a double-edged sword for the Korean economy. They are expected to control speculative demand from those who want to purchase homes by taking out loans from financial institutions and therefore to ease the risk of ballooning household debt. However, shrinking loans will inevitably have a negative effect on private consumption, the real estate market and the construction sector that have propped up the local economy. In fact, the government decided to set a limit for the new DTI rule for fear of a real estate market crash.
A hard landing in the housing market will lead to a rapid decrease of Korea’s economic growth rate. So it is necessary to devise supplementary plans to navigate a soft-landing in the market and find an exit for the construction industry, apart from the debt measures. There are owners of a single, standard-sized home, who are incapable of amortizing the principal of their mortgage loans and want to sell their houses. The Korea Housing Finance Corporation could purchase their homes and turn them into long-term public rental houses. Then, the former homeowners will ease their debt burden. Still, the homes will not be put up for sale in the housing market, resisting the pressure of a plunge in housing prices. What I’m saying is that it is necessary to approach the issue with a separate measure. The household debt policy may not be effective if the government is worried about a contraction in the real estate market in the course of implementing the debt measures.
To enhance the effectiveness of the new measures, the government needs to adopt a two-track approach of separating the debt issue from real estate measures. Aside from the risk management plans, the government could accelerate its efforts to nurture companies and provide stable jobs, hopefully ending a vicious circle of restrictions on loans and an economic recession but creating a virtuous circle of revitalizing the economy.