Economic Letter from Asia: Korean Considerations

This week we turn our attention to South Korea after it revealed an improved economic outturn for Q3 just last week. The economy’s rebound was driven in large part by its semiconductor industry as global chip demand recovered some poise over the period. With that said, while the latest news offers some headline reprieve to South Korea watchers, underlying domestic issues persist. In particular, the indebtedness of South Korean households flags continued reason for concern, as mortgage loans surged following the introduction of 50-year loans in July. The fragility of the situation is further underscored by households’ significant floating-rate loan exposures amid a high-interest rate environment, with delinquency rates already rising in recent months. Against this backdrop, we also discuss the challenges faced by the Bank of Korea. With that said, it seems likely that the central bank keep rates higher for longer, for now, until the data justifies otherwise.

South Korea’s Q3 performance South Korea enjoyed an encouraging turnaround in economic performance in Q3, following three prior quarters of slowing growth. South Korea’s GDP growth rose to 1.4% y/y from 0.9% in Q2 (chart 1), driven by trade, as export growth improved while imports steadied from previous declines. In contrast, growth contributions from private and public consumption were only modest, while capital formation exerted a mild drag.

In line with tepid private consumption growth during the quarter, retail sales growth slowed to 3.3% y/y in September as growth in brick-and-mortar sales slipped into contraction territory while that of online sales remained high. Retail sales have been contracting on a volume basis, however, with a 4.9% y/y decline posted in August following a 1.7% fall in July. On the flipside, growth in industrial production and exports improved as the extent of year-on-year declines eased (chart 2).

South Korea’s semiconductor sector Much of South Korea’s economic improvement can be attributed to its semiconductor sector, which has boosted the economy’s industrial production and exports in recent months. South Korea’s semiconductor sector reached a turning point lately – following an arduous 2022 – as global chip demand started to recover (chart 3). Further, and adding to sectoral optimism, is the US’s latest move to allow major South Korean chipmakers to provide US chip equipment to their China factories indefinitely. For context, South Korea is a major semiconductor supplier to the world with a niche in memory chip markets. Specifically, South Korea’s main DRAM and NAND flash memory chip producers have estimated market shares of 73% and 51% respectively, according to the US International Trade Administration.

South Korea’s household indebtedness South Korea faces persistent domestic issues, however, despite the recent improvements in external demand. In particular, the economy’s level of household indebtedness is of continued concern, with mortgage loan growth having picked up again recently to elevate overall household debt levels. Mortgage loans have risen since July following the introduction of 50-year mortgage loans, which allow borrowers to stretch out their payments further, thereby reducing their monthly outlays. In response, South Korea’s Financial Services Commission unveiled in mid-September measures to manage household debt growth, including tighter screening of debt service ratios (DSR) for longer-term mortgage applicants. The regulator also announced that it will examine if the above-normal DSR rules applied to specialized banks are being sufficiently adhered to.

South Korea’s policy challenges The Bank of Korea (BoK) faces a continued conundrum regarding the aforementioned household debt issues. On the one hand, the BoK may want to clamp down on household indebtedness by keeping rates higher for longer, but at the expense of some loan defaults. On the other, the BoK may also want to ease conditions to avoid an extensive fallout, but at the risk of bigger financial stability problems in the future. Most household loans in South Korea – about 70.8% as of August – are floating rate loans, illustrating the relatively pronounced exposure of households to tightened credit conditions. Additionally, possible lead-lag effects between mortgage interest and delinquency rates are worth considering too, as increased rates may take time to translate to non-performing loans (chart 5).

On balance, however, the BoK is likely to continue to keep conditions tight for now, until either household indebtedness eases moderately or when delinquencies look to reach worrying levels. At present, household loan delinquency rates remain well below historically high levels despite their recent rise, although more increases may already be underway. Additionally, the central bank has the extra justification of resurgent inflation to stand pat on its policy rate for a little longer (chart 6). Rate-based measures aside, South Korean authorities can also try to address household debt levels through macroprudential approaches, as it has already initiated.