Korea’s central bank continues to stand in splendid isolation among its peers in the region. Inflation is rising, yet it declines to hike interest rates. The reason probably lies in the country’s propensity to borrow rather than save — another exception to the Asian rule.
Korean households have now amassed W801.4 trillion ($738 billion) of debt, gearing up by W6 trillion in the first quarter of this year, according to a Bank of Korea (BoK) statement on Wednesday. The trend has been defiantly upward for some time: less than three years ago it broke the W500 trillion barrier.
The ratio of debt-to-disposable income was 157% last year, which ranks Koreans’ borrowing habits at levels associated with the notoriously profligate British and Americans. Last year, household debt totalled 67.8% of GDP and has been on an ascending trend since 2004, according to Commerzbank research; and in April lending to households jumped the most in five months. Households are in hock to commercial banks, shaky mutual savings banks (several were forced to close in February and their problems aren’t over yet), credit card companies and housing finance agencies.
In particular, low interest rates have fuelled a decade-long speculative property bubble. Unfortunately, another feature familiar to the English-speaking nations has emerged, namely negative equity.
Meanwhile, headline consumer price inflation is running at 4.2%, according to April’s figures, well above the official target of 3% and higher than increases in earnings, which in real terms dropped for the second consecutive quarter between January and March this year, and at a time when the job market is stagnant.
Interest hikes, which most economists argue are necessary to curb further inflation in Korea, would hurt already wounded households and even the country’s banks, whose reliance on wholesale money-market funding rather than deposits makes them more vulnerable than others in the region.
A BoK survey published last week showed that 10% of households failed to repay interest on their debts in 2010. And, in a report earlier this month, rating agency Moody’s warned that the country’s record household debt could threaten the stability of Korea’s main lenders, pushing up non-performing loan ratios and principal defaults.
The response of the BoK has been to put interest rate increases on hold, despite President Lee Myung-bak’s clarion call in January for a “war on inflation”. This month, the central bank again surprised pundits by keeping its official rate at 3%, while its governor, Kim Choong-soo, told media that he was confident inflation would fall anyway, and berated economists for their “herd-like” devotion to lagging indicators.
But, it’s hard not to suspect that the level of household debt weighs on policymaking. As Ashley Davis, an analyst at Commerzbank, pointed out, it is unlikely that the usual reason for caution — protecting the exchange rate from excessive appreciation — is an important factor this time around.
The won “is already a very undervalued currency and has not been appreciating significantly recently. We estimate that [it] is 10% below its five-year average on a real effective exchange rate basis. By comparison, the Singapore dollar is presently 9% above its five-year average in real effective exchange rate terms,” he noted.
But, it’s a gamble. Debt-ridden consumers might delay purchases, which could dampen inflationary pressure; on the other hand, maintaining low interest rates might induce them to borrow even more.