(provided by ClipartKorea)
Once household debt passes a certain level in a given country, it starts to impact macroeconomic variables, including default risks and decreased consumption. It can also lead to people working more in order to be able to repay their loans.
South Korea’s household debt exceeds 1.8 quadrillion won (US$1.54 trillion) — roughly on par with its nominal gross domestic product (GDP).
This year, the Bank of Korea (BOK) has released a number of reports and made several remarks on the possibility that rising household debt could lead to reduced consumption. In a “Monetary Policy Report” published in June, it said, “While a suitable amount of debt increases consumption through efficient distribution of resources, debt beyond a suitable level leads to reduced consumption, owing to factors such as increased principal repayment burdens.”
It’s a fairly basic assessment. But it also hints that the scale of debt might be growing beyond what is considered “suitable.”
The BOK went even further in a “Financial Stability Report” published last month. That report identified a specific “critical level” where debt leads to constraints on household consumption: a debt service ratio (DSR) of 45.9% and a loan-to-income (LTI) ratio of 382.7%.
According to the BOK, the debt burden starts to reduce consumption when the amount of principal to be repaid in a given year exceeds nearly half of annual income (45.9%), or when the total of a person’s loans exceeds roughly four times their annual income (382.7%).
Some people have already exceeded the critical level, the bank suggested. Around 6.3% of households were estimated to have exceeded the DSR standard during the first quarter of 2021, while 6.6% were above the LTI standard.
Among low earners and younger people with loans, the percentages above the DSR standard were particularly high at 14.3% and 9.0%, respectively. That means that roughly 1 in 10 people spend essentially all their money paying back loans.
The fact that so many of them have mortgage loans suggests that most of their earnings are going toward real estate repayments — leaving them shackled to their debt. One person’s spending is another person’s income, which means that reduced consumption tends to lead to economic stagnation.
The rise in household debt also creates a vicious cycle where people work more to pay back what they owe.
Like South Korea, the UK is seen as a country with particularly high household debt. Last month, the Bank of England published a report titled “Household debt and labour supply,” where it noted the potential for the household debt repayment burden to affect not only consumer spending but also the labor supply.
Using statistics from 2002 and 2018, the report classified UK households into outright homeowners, mortgagors and renters. The results showed that when the household repayment burden increased with a percentage-point rise in the policy interest rate, labor market participation increased by 0.7 percentage points among mortgagor households.
When mortgagor households experienced difficulties in their ability to repay loans due to factors such as the head of household’s unemployment, the rate of economic activity participation and weekly working hours for the remaining family members rose by 1.9 percentage points and 1.2 hours, respectively. In contrast, no significant changes were observed for outright homeowners or renters.
The report also noted Bank of England household finance survey data showing 60% of households saying they would reduce consumption and 20% saying they would increase their labor supply in the event of an increase in the repayment burden due to factors such as a rise in interest rates.
By Jun Seul-gi, staff reporter
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