COVID-19, Debt Investment, and Yeongkkeul... Will the Debt Bomb Explode Next Year?

The Bank of Korea "Financial Support Termination Impact
Sharp Increase in Self-Employed Debt Repayment Risk Next Year"
Financial Anxiety Index Enters 'Caution' in March
During 2008 Global Financial Crisis
Shifted from Caution to Crisis Stage in 8 Months

[Image source=Yonhap News]

[Asia Economy Reporter Seo So-jeong] Amid the ongoing situation where household and corporate debt in South Korea has reached 2.2 times the size of the entire economy due to the impact of COVID-19 and investment fueled by borrowing (debt investment) and leveraging all assets (all-in borrowing), the Bank of Korea has assessed that next year, when the effects of the end of COVID-19-related financial support fully materialize, the risk of debt repayment difficulties could sharply increase, especially among low-income groups. The Financial Stress Index (FSI), which indicates instability in the financial system, has also been analyzed to have entered a cautionary stage recently.

According to the '2022 First Half Financial Stability Report' released by the Bank of Korea on the 22nd, the ratio of private credit (combined household and corporate debt according to the fund flow statistics) to nominal Gross Domestic Product (GDP) in the first quarter of this year was recorded at 219.4%. This is a 0.1 percentage point decrease from 219.5% in the fourth quarter of last year due to strengthened household debt management and rising loan interest rates, but it still remains at a high level. By sector, as of the end of the first quarter this year, the household credit ratio to GDP was 104.5%, marking a decline for two consecutive quarters, whereas the corporate credit ratio (114.9%) increased compared to the previous quarter. Looking at household debt alone (1,859.4 trillion KRW), it rose by 5.4% year-on-year. The Bank of Korea explained, "As of the end of last year, the outstanding loan balance held by borrowers with mortgage loans and jeonse (key money deposit) loans accounted for 67% of total household loans," adding, "The accumulation of debt repayment burdens and adjustments in housing prices are factors that increase the risk of insolvency for borrowing households."

In particular, with the rapid increase in loans to self-employed individuals after COVID-19, the burden of debt repayment is expected to rise sharply next year, especially among low-income self-employed persons, as the impact of the end of financial support takes full effect. Loans to self-employed individuals stood at 960.7 trillion KRW as of the end of March, a 40.3% increase compared to just before COVID-19, and loans held by vulnerable borrowers among the self-employed also increased by 30.6% to 88.8 trillion KRW compared to pre-COVID-19 levels. The Bank of Korea stated, "It is necessary to shift the financial support policy for the self-employed from liquidity support to debt performance support."

Recently, as volatility in financial markets such as stocks and foreign exchange has expanded, financial system instability has also increased. The Financial Stress Index (FSI), a financial stability indicator, reached 8.9 as of March, entering the cautionary stage (between 8 and less than 22), and surged until the 13th of last month. This index reflects conditions up to May, but given that financial market volatility has expanded following the U.S. Federal Open Market Committee (FOMC)'s giant step (a 0.75% interest rate hike in one go) in June, it is expected to rise further in the future.

Lee Sang-hyung, Deputy Governor of the Bank of Korea, said at a press briefing, "Although this report does not reflect the situation after the U.S. giant step this month, various external risks such as accelerated U.S. interest rate hikes, rising international commodity prices, and China's economic slowdown will continue to act as factors undermining financial stability," emphasizing, "As external risks and financial stability risks increase, all economic agents must remain vigilant and respond proactively."

The FSI is divided into three stages: 0 to 8 is the stable stage, above 8 is the cautionary stage, and above 22 is the crisis stage. The FSI exceeded the crisis stage in April 2020 (24.4), dropped to 0 in June last year, but has been rising again since the second half of last year. This index entered the cautionary stage at 9.2 in January 2008 during the global financial crisis, then escalated to the crisis stage at 27 in September of the same year, and surged to 57.6 in December.

The Bank of Korea stated, "Since the second half of last year, external risks have become more prominent, increasing volatility in financial markets," adding, "With the accumulated household debt and high housing price levels being major vulnerabilities in our economy, the likelihood that domestic and external risk factors will negatively impact financial stability is increasing."

This content was produced with the assistance of AI translation services.