South Korea has a big household debt problem. The country’s unique rental system may be to blame

Central banks, by and large, have one overarching mandate: to ensure price stability and control inflation in a country. Policymakers in South Korea need to contend with another responsibility: managing high household debt.

References to household debt often, if not always, come up in the Bank of Korea’s monetary policy decision.

BOK Governor Rhee Chang Yong said in a speech on Jan. 2 that “there has been some criticism regarding why the Bank of Korea takes household debt into account and appears overly cautious when deciding the Base Rate.”

Why then, is household debt so important to the BOK’s monetary policy considerations? The short answer: it’s too high. The long answer? Much more complicated.

Park Jeongwoo, Nomura’s economist for South Korea and Taiwan, told CNBC that the BOK is concerned about the negative long-term impact of higher household debt on growth.

“The BOK thinks [the] higher debt burden has weakened households’ spending power. At the same time, strong debt-financed demand for housing resulted in distorted capital allocation across the economy, leading to more allocation of capital to not-productive sectors.”

Two factors that contribute to the high amount of debt among households in South Korea is a heavy usage of credit cards, and the unique system of housing in South Korea.

Prospective homeowners can of course, buy their own homes outright, but for those who cannot, they need to rent.

But unlike most rental systems around the world, South Korean renters pay a deposit known as “jeonse” or “key money,” instead of a monthly rent, according to Samuel Rhee, co-founder, chairman and group chief investment officer for wealth platform Endowus.

The jeonse is a deposit about 50%-80% of the market value of the property. At the end of their lease, the deposit is returned to the renter. For the landlord, the jeonse is an interest-free loan, which they are free to invest.

However, renters will usually take out a loan to fund the jeonse deposit, which Rhee said causes “a lot of burden and excess debt in the system for housing.”

He notes that while the overall household debt to GDP ratio has not increased significantly in the past few years, rising interest rates have increased the burden of servicing the debt, “which has been the primary concern for the BOK and Korean government.”

Rhee pointed out that while the BOK had cut rates twice to take them to 3% at the end of last year, the banks have not passed on the lowered interest rates to consumers.

This means that while the BOK has cut rates, renters’ interest costs have not gone down.

Ryota Abe, who is an economist at the global markets and treasury department for Asia Pacific at Sumitomo Mitsui Banking Corporation, said that the household debt ratio in South Korea is of concern because it could affect the country’s economic growth by making the financial sector fragile.

“In case [a] credit crunch happens because the borrowers are not able to repay the debt as it is too huge, the issue will bring deflationary pressures as well as an economic recession.”

Abe cited figures by the Bank of International Settlements, which said South Korea’s household debt ratio stood at 91% of GDP as of the second quarter of 2024. In comparison, household debt in other advanced countries stands at 68.9% on average.

For comparison, data from the International Monetary Fund showed the country having the highest household debt to GDP ratio among Asian countries in 2023, at 93.54.

China, Asia’s largest economy, had a ratio of 63.67, while for India it was 39.16. Japan had a ratio of 65.66 in 2023.

Abe also said the ratio of debt to net disposable income was 186% in 2023 in South Korea, having ballooned from 130% in 2008.

Data shows that the speed of the debt increase is faster than the rise in wages and GDP, implying that the South Korean economy, particularly the household sector, depends highly on debt, Abe said.

“In a case where the sector fails to repay the debt, the negative shocks would be huge, which wouldn’t be limited in the sector but to the financial sector. If such a shock happened, the economy will be in catastrophe. Therefore, the Korean authorities need to reduce such risks beforehand,” he added.

The BOK faces a tricky path. It needs to cut rates so as to stimulate a slowing economy and alleviate the debt servicing burden, but a rate cut would weaken the won and may increase imported inflation.

More importantly, Endowus’ Rhee said a rate cut could spur an increase in potential demand for houses, leading to an acceleration in outstanding household debt.

“If you lower interest rates and debt increases and this is used to stimulate housing demand, which causes house prices and rental prices to rise, then it is inflationary and BOK would want to limit the inflationary impact,” Rhee said.

Alex Holmes, research director for Asia at the Economist Intelligence Unit told CNBC’s “Squawk Box Asia” earlier in January that 2024 was the first year that household debt had come down as a percentage of GDP, and the BOK will not want to cut rates too quickly to prevent a rebound.