[Inside Chodong] The Path of South Korea's 'Debt Insensitivity'

The national debt held by the Japanese government is among the highest in the developed world. According to the Organisation for Economic Co-operation and Development (OECD), as of the end of last year, it exceeded 1,212 trillion yen, or approximately 1,140 trillion won. The debt-to-GDP ratio stands at 227.42%, the highest in the world. This surpasses even the United States, which has a long history of fiscal expansion (136.62%), and is twice as high as Greece (169.26%), which once shook the European continent with its sovereign default crisis. In other words, Japan is the most heavily indebted nation among advanced economies. In contrast, South Korea’s debt ratio is significantly lower at 56.74%. This context makes the argument by the Ministry of Economy and Finance?that South Korea’s debt ratio is lower than that of advanced economies and that there is still ample room to take on more debt?sound reasonable. But is this really the case?

We usually determine how much we spend based on how much we earn. A debt-to-GDP ratio of 227% means that the country has borrowed more than twice what it earns. However, there is a big difference between a person who earns 40 million won a year and takes out a 1 billion won loan without any assets, and someone who earns the same amount but has over 600 million won in net assets before taking out the same loan. The more assets one has accumulated, the less risky it is to take on additional debt.

This is the situation in Japan. Despite its astronomical debt exceeding 1,000 trillion yen, the Japanese economy endures because it has the capacity to handle the debt. Japan’s household debt ratio is only 65%. With one of the highest savings rates in the world, Japanese households have substantial net assets. The money accumulated through savings in domestic financial institutions is used to meet the demand for government bonds. Although foreign investors have recently increased their holdings of Japanese government bonds, the proportion held by foreigners remains just 13%. The remaining 87% is held by Japanese financial institutions, including the Bank of Japan. Based on a robust domestic economy, the private sector absorbs the vast majority of the national debt. Ultimately, the enormous interest payments on government bonds flow back to Japanese citizens.

In contrast, South Korea’s household debt-to-GDP ratio has swelled to 90%. Household debt accounts for half of all private sector debt. With the total amount of household debt being large and most assets tied up in real estate, Korean citizens are not in a position to purchase government bonds. About a quarter (23% as of May this year) of Korean government bonds are held by foreign investors. Foreign investment in government bonds continues to rise each year, thanks to measures such as the opening of omnibus accounts and tax exemptions. With the formal inclusion in the World Government Bond Index (WGBI) starting next year, this is expected to increase even more rapidly. Up to 80 trillion won could flow into the domestic bond market. This is why there are constant warnings that excessive annual borrowing and over-issuance of government bonds could lead to a downgrade in the national credit rating. A decline in national creditworthiness could trigger foreign capital outflows and currency instability, potentially leading to a second foreign exchange crisis. For a small, open economy with a high degree of external dependence, fiscal soundness is a matter of survival.

Furthermore, South Korea is not an issuer of a key international currency. Unlike the yen, which holds the status of a safe asset like gold or the US dollar in the international community, or Japanese government bonds, which are treated as safe assets due to being denominated in yen, South Korea is in a different position. Countries issuing key currencies enjoy strong demand for their government bonds and can continue to increase debt without the burden of rising interest rates, and face relatively lower risks of credit rating downgrades. The appropriate debt threshold is fundamentally different for South Korea, where demand for bonds is lower and interest rate conditions are less favorable. According to the long-term fiscal outlook of the Lee Jaemyung administration, the national debt ratio is projected to soar to 173% in 40 years. This would surpass the United States and put South Korea on the path of Japan. With unprecedentedly rapid aging, it is predicted that about 15 years from now, when those born in the 1970s begin to retire in earnest, the nation’s fiscal health will begin to deteriorate beyond control, and the impact will become pronounced. While Japan has endured its “lost 30 years” despite astronomical debt, there are concerns that South Korea may not last even 15 years if it recklessly increases its debt burden.