South Korea Grapples with Household Debt Crisis Amid Unique Rental System Dynamics

South Korea is facing growing economic challenges as household debt continues to be a significant concern for policymakers, CNBC reports.

The Bank of Korea (BOK) frequently references household debt in its monetary policy decisions, reflecting the scale of the problem and its potential long-term impact on the nation’s economic stability.

While central banks typically focus on price stability and inflation control, the BOK must also contend with the task of managing household debt levels. BOK Governor Rhee Chang Yong addressed this issue in a recent speech, acknowledging criticism for the bank’s cautious approach to rate-setting due to concerns over debt.

Economist Park Jeongwoo from Nomura highlighted the adverse effects of South Korea’s debt burden, stating that it has weakened household spending power and distorted capital allocation, diverting investments from productive sectors.

One unique factor contributing to high household debt is the country’s distinctive rental system known as jeonse. Unlike conventional rental agreements that involve monthly payments, jeonse requires tenants to pay a substantial deposit—typically 50% to 80% of a property’s market value.

This deposit is returned at the end of the lease, but many renters take out loans to afford the hefty sum. According to Samuel Rhee, co-founder of wealth platform Endowus, this system places a significant financial burden on households and inflates the nation’s debt levels.

Although the BOK reduced interest rates to 3% at the end of last year, banks have not passed on the savings to consumers, keeping borrowing costs high.

South Korea’s household debt ratio, at 91% of GDP as of the second quarter of 2024, is among the highest globally. Ryota Abe, an economist at Sumitomo Mitsui Banking Corporation, warned that such high debt levels could destabilize the financial sector and trigger an economic recession.

“If borrowers cannot repay their debts, it could lead to deflationary pressures and an economic catastrophe,” Abe cautioned.

Comparatively, other advanced economies have an average household debt-to-GDP ratio of 68.9%, according to the Bank of International Settlements. Additionally, South Korea’s debt-to-net-disposable-income ratio surged from 130% in 2008 to 186% in 2023, underscoring the rapid growth of household borrowing relative to income.

The BOK faces a complex dilemma. Cutting interest rates could stimulate the economy and ease the debt burden, but it risks weakening the Korean won and increasing imported inflation. Moreover, rate cuts may encourage greater housing demand, exacerbating household debt and driving up property prices.

“If you lower interest rates and debt increases, stimulating housing demand, it can lead to inflationary pressure,” warned Endowus’ Rhee.

Despite these challenges, there have been signs of progress. Alex Holmes, research director for Asia at the Economist Intelligence Unit, noted that 2024 marked the first year household debt declined as a percentage of GDP.