Will BOK's rate cut aggravate the problem of household debt in Korea?

Will BOK's rate cut exacerbate the problem of household debt in Korea? From the BOK's point of view, the answer is 'yes'. According to the latest Monetary Policy Committee Minutes, all of the meeting members argued that the increase in household debt is a main concern for additional monetary accommodation. Their main argument is that the lower interest rates will cause the increase in total lending to households in Korea.


Exhibit 1.Korean household debt(y-o-y) & the BOK's policy rate

(source : BOK)

The Exhibit 1 shows the y-o-y change in total household debt and the change in policy rate in Korea, as of 3Q 2014. The increasing rate of total household debt has been accelerated, since the BOK's rate cut in 2Q 2012. Accordingly, considering record-high household debt(around 1,040 trillion won), the arguments of the BOK's voting members seem reasonable.

By the way, what if we change our perspective of the 'problem of household debt'? What if we see a pragmatic measurement of household debt instead of a total size of household debt? Here I illustrate two cases like a table below.


Exhibit 2.

The case 1 describes the interest charge to household in case of the current policy rate, with an assumption of 7% annual growth rate of the total household debt. The case 2, on the other hand, represents the interest charge to household in case of 50bp rate cut, with an assumption of 10% annual growth rate of the total household debt.

The Exhibit 2 clearly shows that the rate cut would reduce the burden of the household, because a rate of decrease in interest charge(17%) is much bigger than a rate of increase in total household debt(10%). The reason why this phenomenon occured is that the absolute level of interest rate is already low. If the current interest rates stayed above 5%, the rate of decrease in interest rate should drop to 10%(5% -> 4.5%).

Setting aside the household income accumulation effect driven by a boost in business condition through the rate cut, the BOK's additional rate cut will not aggravate the problem of household debt, in my view. Even if the size of household debt is still agitated, that issue should be controlled by a stricter loan regulation like DTI/LTV, not by a monetary policy.