[Inside Chodong] How Yeongkkeul Is Damaging the Economy

Household Debt Rises to Risky Levels Due to Real Estate Yeongkkeul
Sluggish Consumption, Increased Financial Market Volatility, and Widening Wealth Gap

Changhwan Lee, Deputy Head of the Economic and Financial Department

As the United States lowered its benchmark interest rate by 0.5 percentage points, interest is growing over when South Korea will follow suit and cut its rates. While the prevailing forecast is that the Bank of Korea will reduce the benchmark rate next month, there are also voices suggesting that the timing of the cut may be delayed due to expanding household debt.

The government wants to lower the benchmark rate as soon as possible to overcome sluggish domestic demand, but the Bank of Korea’s concern over household debt is justified. As of the first quarter of this year, South Korea’s household debt-to-GDP ratio stood at 92%, placing it among the highest ranks in the Organisation for Economic Co-operation and Development (OECD). Recently, with rising housing prices in the Seoul metropolitan area, loans taken out by stretching to the limit (Yeongkkeul, meaning "borrowing to the soul") have increased, making it highly likely that the already high household debt ratio will rise further in the second half of the year.

The Bank of Korea points out that while rising housing prices theoretically can stimulate the economy through increased construction investment and the wealth effect, in South Korea’s case, it actually acts as a factor that depresses the economy. In particular, excessive household debt caused by the increase in Yeongkkeul borrowers can trigger various economic side effects.

A representative issue is sluggish consumption. Households with heavy debt have insufficient funds to spend on consumption because they must repay interest. In the second quarter, South Korea’s private consumption decreased by 0.2% compared to the previous quarter, as goods such as passenger cars and clothing did not sell well. The decline in consumption risks creating a vicious cycle that leads to reduced corporate investment and production, which in turn lowers household income. Additionally, with household debt concentrated in real estate investment, the burden of real estate-related taxes on households may further reduce their consumption capacity.

The second issue is increased volatility in financial markets. When domestic or external economic shocks occur, such as a recession or real estate project financing (PF) defaults, households with excessive debt are more likely to default, which can undermine the soundness of financial institutions. The beginning of the 2008 global financial crisis was also rooted in household debt and the housing bubble.

Excessive household debt exacerbates wealth polarization. In South Korea’s case, household debt is concentrated in the real estate market, and rapidly rising housing prices have deepened economic inequality. As of June, the average apartment sale price in Seoul was 1.22155 billion won, making it nearly impossible for ordinary workers in their 20s and 30s to afford despite their hard work. One of the main reasons for the increasing number of young people giving up on marriage and childbirth is the rise in housing prices.

There is also analysis that household debt, which has grown too large relative to economic capacity, is hindering South Korea’s economic growth. The Bank for International Settlements (BIS) recently reported that South Korea’s private credit-to-GDP ratio exceeds the 100% threshold, reaching a level that restricts economic growth. Due to consumption constraints and interest burdens caused by excessive debt, the country’s potential growth rate is being eroded.

Excessive household debt also makes the public’s retirement insecure. Because people buy real estate by taking on debt, the cash flow needed for retirement is disrupted. Although 80% of the assets of the elderly are in real estate, South Korea has the highest elderly poverty rate in the OECD. Even owning a home, without income, leads to poverty in old age.

Household debt cannot be controlled by the Bank of Korea alone. To curb debt, the Bank would need to raise interest rates, but with the U.S. implementing a big cut (a 0.50 percentage point reduction in the benchmark rate), the Bank of Korea is in a position where it must lower rates as well. The Bank of Korea will cut rates, making government management of household debt even more important. This is why the government must strictly manage household debt with clearer standards.