The Creation of A
Debt Crisis

BY KENISHA MARTINS / FEBRUARY 05, 2022

Investigating the critical debt issue that South Korea faces that has led the country’s household debt to reach astronomically high levels.

urrently, South Korea’s household debt to GDP ratio is one of the highest among major economies around the world and the highest in all of Asia. South Korean Central Bank’s "Monetary Credit Policy Report," showed that household debt reached 105% of GDP in the first quarter of 2021, equivalent to approximately USD 1.5 trillion at the end of March. The report also shed light on the growing income disparity in the country where the top 20% of the nation’s earners have a net worth 166 times greater than the bottom 20%. This disparity has increased by 50% since 2017 and has been exasperated due to the ongoing pandemic.

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Pictured: Graph by Bank of international settlements Via Google

To understand how South Korea landed in such a predicament with staggering amounts of debt, we will have to look at the financial history of the country. After the sky-high inflation rates and low growth levels in the late 1970s, the country was forced to make some enormous structural changes to the economy. Comprehensive measures were implemented to shift the country’s growth strategy from a government-led one to a market-led one to improve its economic efficiency. With these strategic changes along with the backdrop of the weak U.S dollar, low oil price, and low international interest rates, South Korea had a massive economic boom in the early 1980s. This, in turn, led South Korea in 1992 to open its doors to foreign investors and join the Organisation for Economic Cooperation and Development (OECD). This resulted in an influx of massive volumes of capital in the South Korean market in the form of foreign debt, especially short-term debt.

The report also shed light on the growing income disparity in the country where the top 20% of the nation's earners have a net worth 166 times greater than the bottom 20%

However, this economic prosperity would soon come crashing down with one of the worst financial crises the global south has ever experienced, The Asian Financial Crisis of 1997. The East Asian financial crisis had devastating impacts on not only the economy of South Korea but also the economies of Indonesia, Thailand, Malaysia, and the Philippines. The roots of which came from the financial reforms that were happening in these countries at the time. The financial structures in these developing countries were riddled with partial or incomplete regulations, loopholes in the reforms and corruption that made it difficult to supervise the expansion in the banking sector. This made the economies of the countries extremely vulnerable to international financial shocks due to the build-up of the inflow of capital from foreign investors.

Illustration by Joanie Bernstein via Pinterest.jpg

Pictured: Illustration By Joanine Bernstein Via Pinterest

So when the financial crisis finally broke out in November of 1997, many conglomerates in South Korea went bankrupt due to their inability and unwillingness to adjust their production and investment. Many major chaebols, which is a large industrial conglomerate that is run and controlled by a person or family, due to their rigid and bureaucratic management system, with decision-making rights concentrated at the top, became bankrupt. At the time we saw that the proportion of non-performing loans almost doubled and commercial banks became less willing and more selective in accommodating their credit needs. This led to a massive outflow of capital as investors started withdrawing from the Korean economy. Thus, Korea suffered from a currency crisis at the end of 1997. In the wake of this financial crisis, the government designed several mechanisms to cushion the economic downturn. These economic reforms, though effective, are what caused the credit card lending boom.

Illustration by unknown via Pinterest.jpg

Pictured: Illustration By unknown Via
Pinterest

Following the crisis, the South Korean government was successful in containing the downward spiral of the economy, one of their strategies among others, included aggressively controlling the financial institutions to keep the country’s credit system intact. To incentivise spending and boost economic activity, the government created policy packages that included tax benefits for merchants accepting credit cards and income tax deductions linked to their credit card purchases. Along with this, a weaker corporate loan demand, ample liquidity in the banking system and lower interest rates due to the ongoing crisis created a larger focus on consumer lending.

The financial liberalisation period in South Korea at the time also added to the credit card crisis. the 2003 credit crisis led the government to bailout major credit companies and reform their operations through stricter criteria for loans. However, the situation had not improved at all. In 2009, Koreans owned more than 100 million credit cards, nearly the same number as in 2002, the year before the crisis occurred. The current situation remains the same, in 2019 it was estimated that the average South Korean had approximately four credit cards, which accounted for 71.7% of the total private spending that year.

The current situation remains the same, in 2019 it was estimated that the average South Korean had approximately four credit cards, which accounted for 71.7% of the total private spending that year.

Korean Won illustration by unknown via P

In the years following the crisis, there has been a surge in quick credit schemes and credit companies. Along with this, there is also loosening of credit limits and manipulation of documents that make getting credit much easier. This has led to a high number of defaults on credit payments. KEB Hana Card’s default rate increased from 1.72 % in the first quarter of 2018 to 1.96 % in the first quarter of the year, 2019. This debt is most likely to affect millennials as unemployment levels skyrocket among those aged 15 to 24, having 10.5 % in 2018, according to the OECD. As more millennials are unable to secure jobs, they have some of the highest bankruptcy rates.

Pictured: Illustration By Unknown Via Pinterest

The youth of South Korea are not the only group currently drowning in debt, a lot of self-employed business owners are trapped as well. As the pandemic prolongs, lockdowns and restrictions extend, many businesses struggle to remain open and small business profits have plummeted to 43%, according to the National Statistics Office. South Korea’s government has been unable to provide sufficient relief to these businesses. South Korea’s spending amounted to only 6.4% of GDP in fiscal measures, compared to the economies of Germany and Japan that have rolled out support equivalent to more than 15%.

Economist Han Sang-wan, former head of research at the Hyundai Research Institute added "The property prices will continue to surge to the end of this year and on to next year and if the bubble bursts, Korea will be dealt a harsher blow compared with the US,"

Some experts believe that currently, the real estate market of the country has entered into an asset bubble. Asset bubble occurs when prices of housing assets, stocks, or gold rise exponentially over a short period of time and are not supported by the real value of the product. Economist Han Sang-wan, former head of research at the Hyundai Research Institute added “The property prices will continue to surge to the end of this year and on to next year and if the bubble bursts, Korea will be dealt a harsher blow compared with the US”. This has made homeownership extremely difficult in major cities like Seoul, where the average cost of a home rose by 22% in 2020, hitting a 19-year high.

Illustration by unknown via Pinterest (1).jpg

Pictured: Illustration by unknown via
Pinterest

Being wary about the current situation at hand the South Korean government has taken some action. They have started looking for ways to tighten the rules for home-backed loans and slow the growth of household debt. Currently, commercial banks have started to temporarily halt either all or some of their mortgage lending. Along with these measures, lending regulations are under review as more people turn to non-banking institutions to borrow money to avoid stricter rules on bank loans. Though these are steps in the right direction, Sam Kyungmoon Son, an adjunct lecturer at Kyungwoon University and an independent consultant at management consulting firm Visionwise LLC, says that this is just the first of many steps to address the root of the debt crisis. He adds that personal debt will continue plaguing the lives of many young millennials. "Seeing loan sharks demanding organs if people don't have cash to pay for their loans is an exaggeration. But the current situation where heavily indebted young people find themselves relying on credit to make purchases beyond their means is a very real problem," Son said.

Despite South Korea’s best efforts to curb the spending of households, due to the high cost of living and rising property rates, many households might eventually default on their debt. Most experts believe that the government must not only implement spending curbs but also focus on creating more jobs for the next generations and stabilising the property market.

Keywords

South Korea, Monetary Credit Policy Report, economic crisis, Asian Financial Crisis, chaebols, asset bubble

References

McCurry, J. (2021, October 8). Squid game lays bare South Korea's real-life personal debt crisis. The Guardian.
Squid Game lays bare South Korea’s real-life personal debt crisis | Squid Game | The Guardian

Teh, C. (2021, October 21). South Korea's millennials say their lives aren't that different from 'Squid Game' as they face a crisis of mounting debt, unaffordable homes, and dead-end jobs. Insider. Seoul's Millennials Say Their Lives Aren't Too Different From the Dire Realities in 'Squid Game' (insider.com)

Kang, K., Guonan, M. (2009). Credit card lending distress in Korea in 2003. BIS Papers Bank for International Settlements (ed.), Volume 46, pages 95-106.

Kwon, Y. (2021). The Long Shadow of the Asian Financial Crisis in South Korea. The Diplomat. The Long Shadow of the Asian Financial Crisis in South Korea – The Diplomat

Song, J.(2021). South Koreans in the Debt Crisis: The Creation of a Neoliberal Welfare Society. Duke University Press Books.

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