[The Editors' Verdict] The Government's Perspective on Financial Imbalance

[Asia Economy Reporter Choi Il-kwon] The government's concern ahead of next month's phased return to normal life under the 'With Corona' policy is financial imbalance. Financial imbalance occurs when market funds flow more into asset markets such as real estate rather than into investments or the real economy. Last year, massive liquidity was released due to ultra-low interest rates, causing real estate prices to soar and the prices of stocks and cryptocurrencies like Bitcoin to surge. This was the result of funds flowing into asset markets. How to resolve this phenomenon is considered a key task for economic recovery by the government.

Financial imbalance is caused by the massive debt accumulated since the COVID-19 crisis. According to the Financial Stability Report recently released by the Bank of Korea, the gap (trend gap) between household and corporate credit (loans) and GDP in the second quarter was 5.3 percentage points and 7.0 percentage points, respectively, expanding by 0.7 percentage points and 5 percentage points compared to the end of the previous year. This means that the pace of credit growth is faster than the GDP growth trend, a phenomenon that has become more pronounced since COVID-19. The low cost of money (interest) encouraged everyone to join the borrowing spree. The borrowed funds flowed more into asset markets than into facilities, stimulating rises in real estate and stock markets.

Asset markets do not enhance productivity and thus hinder sound economic growth. Their value is also unstable, easily shaken by external factors. For this reason, financial imbalance is expected to become a weak link in the Korean economy in the medium to long term. Deputy Prime Minister and Minister of Economy and Finance Hong Nam-ki recently raised concerns, stating, "It is necessary to review ways to mitigate the side effects caused by the accumulated financial imbalance."

The government's biggest concern about financial imbalance is the possibility of asset prices falling. If the bubble bursts, the debt remains intact, causing credit problems. The resulting risks could extend beyond asset markets to the financial system, including banks. Therefore, the government has urged restraint in speculative buying, and the Bank of Korea has also expressed concerns that "the rapid rise in asset prices such as real estate could undermine financial stability if economic agents' sentiment changes abruptly due to internal or external shocks."

The ultra-low interest rate monetary policy, which was implemented to prevent liquidity crunch, ended with the base rate hike in August. This marked the start of policies affecting asset markets such as real estate. Since another rate hike is likely within this year, liquidity will further decrease.

However, the strong upward trend in the real estate market shows little sign of abating. The Housing Sales Price Index by the Korea Real Estate Board, which reflects changes in transaction prices, slightly fell from 90.6 in December 2018 to 90.3 at the end of 2019 but has continuously risen since then, reaching 101.8 in August. The housing price increase trend remains unabated, reflecting a stronger desire for home ownership than concerns about loan repayment.

The market widely believes that asset prices are unlikely to change drastically in the short term. Rather, as long as real estate policies that restrict both sales and rental demands?such as the right to request contract renewal and increased capital gains tax?remain in place, the phenomenon of asset concentration cannot be prevented. This view gains credibility as evidenced by the recent rush of 130,000 people applying for about 500 apartment units in Seoul, indicating that the real estate frenzy continues. If real estate prices are maintained, the likelihood of adverse effects on the financial system also decreases.

Will a crisis caused by financial imbalance occur? A former senior official, speaking privately, said, "A predicted crisis is not a crisis." While the government is concerned about the concentration of funds in asset markets, it expects comprehensive real estate tax revenues to increase next year. The government's true thoughts on financial imbalance remain to be seen.