Higher-for-longer US interest rates could spark insolvency explosion in Korean economy

Posted on : 2023-10-30 16:51 KST Modified on : 2023-10-30 16:51 KST
Households and companies that expected their debt burden to decrease in the second half of 2023 are pained by a longer-than-expected period of high interest rates
(ClipartKorea)
(ClipartKorea)

Two years ago, a man in his 40s surnamed Han bought an apartment worth 600 million won (around US$443,500) by putting everything but his soul on the line. He took out a mortgage and a credit loan totaling 400 million won while the interest rates were 3.05% and 4.60% per annum, respectively. But recently, these rates have respectively soared to 4.46% and 6.99%.

As for the credit loan, when rates jumped to 7.61% per annum at the end of 2022, Han switched banks to a loan in the low-6% range, but the rate is on the rise again.

“I’ve been trying to stay strong in the hopes that rates will go down by the end of 2023, but if that doesn’t happen, I’m wondering if I’ll need to sell my house,” Han said.

The possibility of “higher for longer” interest rates in the US that has been looming on the horizon since late September has disrupted the debt management plans of government authorities, households, and businesses in the Korean economy.

Households and companies that expected their debt burden to decrease in the second half of 2023 are pained by a longer-than-expected period of high interest rates. There are also concerns that real estate project financing and loans taken out by self-employed borrowers, which have been propped up by extending maturities, are failing.

South Korea’s economy, which has weaker economic fundamentals than the US, is in the midst of a high-interest rate crisis.

As of Sunday, the lower end of household loan rates at the four major banks — KB Kookmin, Shinhan, Hana and Woori — jumped by 0.090 to 0.460 percentage points in the span of a month.

As of Friday, interest on adjustable-rate mortgage loans (based on the new cost of funds index) ranged from 4.570% to 7.173% per annum, and interest on blended rates ranged from 4.360% to 6.760% per annum. Lending rates (Tier 1; one year) range from 4.650% to 6.650% per annum.

No longer is the lower end of the lending rate in the 3% range, and the upper end of the rate has broken through the 6% range ceiling. This rate also applies to existing borrowers (products with floating rates).

Interest rates on household loans decreased slightly in June and July, but have been on the rise since August. Even though the Bank of Korea has kept the key interest rate unchanged since February, market rates have been volatile.

The reason being that the 10-year US Treasury yields have been hitting 16-year highs day after day since Sept. 21 on concerns of prolonged high interest rates due to the strong economic development in the US. It even reached 5.00% on Oct. 19.

Bond rates, which are the benchmark for domestic lending rates, are also on the rise. For example, the five-year bank bond (AAA, unguaranteed, average of five credit rating agencies) rate has been hovering around 4% per year since May and hit a new high of 4.797% on Oct. 23.

In addition, financial institutions are raising their deposit rates and issuing more bank bonds to attract high-interest deposits that have recently matured (an estimated 100 trillion won from October to the end of the year), and they are also raising additional interest rates to curb the growth of household loans, resulting in lending rates being pushed up further.

Households with a lot of debt are in a quandary. Among borrowers who leveraged just about everything they had to buy their home during the low-interest rate era, many are becoming unable to stick out prolonged high interest rates.

Last month, 216 apartments were auctioned off in Seoul, the highest monthly number in a little over seven years. Real estate industry watchers say the number of auctions of apartments by young people who are unable to repay their loans is on the rise.

The possibility of a soft landing for indebted self-employed small business operators is also threatened with setbacks.

In the wake of measures extending due dates for loans to small businesses and deferring repayment through September of this year, the government has introduced a “new beginning fund” debt restructuring program to soften the debt blow for small business operators.

The number of small- and medium-sized businesses receiving financial support has been steadily dropping, reaching 350,000 as of late June 2023 — down by 83,000 from the end of September 2022. This means that more and more of these operators’ financial situation has improved enough for them to start repaying their debts, but even that kind of soft landing cannot be guaranteed if the high interest rates persist into the future.

Larger corporations aren’t free from the debt burden either. After registering an annual percentage of 5.20% last April, the interest rate for corporate loans (weighted average, outstanding) has risen since then to reach 5.28% as of September.

Among the 488,000 non-financial companies that face interest costs, the proportion that are not even able to pay interest based on their operating profits reached a historic high of 42.3% last year, according to the Bank of Korea’s “Financial Statement Analysis.”

Meanwhile, some are voicing fears that real estate project financing could end up erupting as a trigger for the South Korean economy as a whole.

In a parliamentary audit on Oct. 23, BOK Governor Rhee Chang-yong said, “The biggest concern if the interest rate goes up again has to do with real estate project financing.”

“If housing prices fall by more than 30% from their high, this creates problems for financial institutions and project financing,” he explained.

To date, authorities have been using various normalization policies to stop real estate project financing defaults. The government and creditors have been providing construction businesses with new funds and loan extensions — effectively buying time until interest rates go down and the business situation improves.

Around 10% of the 200 or so project financing businesses have undergone restructuring. In particular, many bridge loan extensions have been granted; as of March 2023, 55.9% of bridge loans had received at least one extension, while 19.2% had been extended twice or more.

In extending these loans, the government and creditors have presumed that business conditions should improve by around next year. But if the high interest rates lengthen the timeline for project financing conditions to improve, defaults could end up erupting. Non-apartment and regional construction businesses are seen as being in particular danger.

As the high interest rates clearly take shape as a long-term trend, analysts are voicing fears that insolvency could end up surfacing in various quarters next year for a South Korean economy that has recorded a growth rate below 1% for three straight quarters this year and is experiencing a decline in its potential growth rate amid demographic changes and other factors.

On Wednesday, the Hana Institute of Finance warned that “insolvencies could become a reality next year for self-employed small businesses, marginal businesses, and real estate project financing businesses in particular.”

In an Oct. 11 interview with the US network CNBC, Rhee said that long-term high interest rates have emerged as a new regime globally, and that South Korea faces a high structural likelihood of long-term low growth due to its low birth rate and population aging trends.

By Jun Seul-gi, staff reporter

Please direct questions or comments to [english@hani.co.kr]

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