[Opinion] Solutions to the Debt Crisis

Recently, Krishna Srinivasan, Director of the Asia-Pacific Department at the International Monetary Fund (IMF), pointed out the excessive household and corporate debt in the Korean economy. Kenneth Rogoff, a professor at Harvard University, is also warning of a debt crisis in emerging markets caused by a debt supercycle. While low interest rates have driven up real estate prices, increasing collateral values and thus loans, a real estate bubble burst due to high interest rates could trigger a debt crisis and low growth during the deleveraging process as loans shrink.

The Korean economy has also seen a surge in real estate prices due to prolonged low interest rates, with real estate-backed loans increasing significantly. In the second quarter, household credit reached 1,862 trillion won, exceeding 100% of the gross domestic product (GDP). If high interest rates persist and real estate prices fall, there is a growing concern about the possibility of a debt crisis where borrowers cannot repay principal and interest. It is urgent for policymakers to prepare countermeasures.

First, caution is needed regarding the rapid increase in loan interest rates. Recently, the U.S. third-quarter growth rate came in close to 5%, raising the possibility of further rate hikes by the U.S. Federal Reserve (Fed). In Korea, funding costs have risen, pushing loan interest rates above 7%, and there are calls to raise rates further to reduce the growing household debt.

However, unlike the U.S., Korea is experiencing an economic recession, and the increased interest burden from high rates has already raised delinquency rates. This is evident from the recent sharp rise in unsecured loans compared to mortgage loans. In this situation, further increases in loan interest rates could trigger a debt crisis. Financial authorities should be cautious about excessive interest rate hikes to prevent a rise in financial distress and stabilize the livelihoods of ordinary citizens.

Loan reduction should also be implemented gradually. It is necessary to reduce not only the excessively large household debt but also corporate debt. However, abrupt deleveraging can cause a crisis. If high interest rates are combined with tightened loan regulations, delinquency rates?which are already rising?could increase further. The IMF Asia-Pacific Director also recommends a slow reduction of household and corporate debt. Supplementary measures are needed for ordinary citizens and small business owners suffering from high interest rates and economic recession. Expanding financial support for low-income households and extending loan terms for small business owners can help mitigate the side effects of deleveraging.

Preventing a hard landing of the domestic economy is also important. Most debt crises occur when there is a hard landing or prolonged high interest rates. The current policy mix of tight monetary and fiscal policies used by the government is effective in promoting corporate restructuring, securing fiscal soundness, and stabilizing inflation.

However, in an open capital market economy, such policies can cause a hard landing, triggering capital outflows and financial crises. Before the 1997 foreign exchange crisis, Korea also experienced a crisis due to excessive tightening policies aimed at corporate restructuring. Because of such side effects, the U.S. is raising interest rates sharply but easing fiscal policy to induce a soft landing. Korea’s recession is more severe than that of the U.S. To avoid a debt crisis, policymakers need to be cautious in choosing the mix of monetary and fiscal policies to achieve a soft landing.

One must be more careful when going down than when going up. This is because energy is already depleted when going up, making it easier to fall and get hurt when going down. Past cases show that debt crises often occur one to two years after interest rate hikes stop rather than during the rate hike period. This is because rate hikes take time to contract the economy, and over time, the sustained high interest rates make it difficult to bear the interest burden. Although the COVID-19 pandemic is ending, cautious policy choices by authorities are more important than ever to avoid the impending debt crisis.

Kim Jeong-sik, Professor Emeritus, Department of Economics, Yonsei University

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