[Editorial] Alarming debt growth

South Korea’s rapidly climbing household debt is a key factor hampering the nation’s growth potential.

Its significance is evident when we compare the growth of the nation’s gross domestic product and collective household debt in the first quarter.

While GDP inched up 2.7 percent on-year during the first three months, the nation’s household debt surged 11.4 percent on-year, or 125.5 trillion won ($106 billion), to reach 1.223 quadrillion won.

Korea’s household debt is fast approaching its annual GDP, which amounted to $1.32 trillion last year.

As many economist have noted, there is no doubt that the mounting household debt has weakened ordinary citizens’ purchasing power. This is blocking a noteworthy bounce back in private consumption, which takes up a large portion of GDP.

To make matters worse, many debt-ridden households are taking additional loans from financial firms to secure cash to buy basic necessities or pay back some of their maturing debt.

It is not easy to break out of the vicious circle in which debt is yielding more debt.

Furthermore, data from the Bank of Korea showed a rapid increase in loans issued by secondary financial firms. This is critical, as it means more and more households are no longer eligible to take loans from first-tier commercial banks.

The government has contributed to this unfavorable situation. With outstanding mortgage loans shooting up last year amid President Park Geun-hye’s initiative to boost the real estate sector, the Financial Services Commission has been urging commercial banks to conduct rigid loan screening.

The FSC had played a core role in inducing a great number of households to take mortgages from the first-tier banking sector by easing regulations such as the loan-to-value ratio and debt-to-income ratio.

As a result, a large portion of the middle-income bracket is estimated to have resorted to second-tier lenders -- such as mutual savings banks and capital services firms -- which charge borrowers higher interest rates from 10 to 20 percent per annum.

BOK data showed that the loans issued by second-tier lenders accounted for 72.8 percent of the newly added household debt during the first quarter of the year. The growth of second-tier loans far outpaced that of first-tier loans -- 15 trillion won vs. 5.6 trillion over the same period.

Despite a series of warnings from analysts at home and abroad, local policymakers – including the Finance Ministry, the FSC, the Financial Supervisory Service and the Bank of Korea -- have not been active in unveiling a road map to curb consumer debt.

They, moreover, have played a key part in raising apartment prices across major cities amid snowballing mortgage balance.

A serious cause for concern lies in the possible hard landing of household debt when the alleged property bubble bursts in the near future.

The era of record-low base rate, set at 1.5 percent, could end in the coming months as the U.S. Federal Reserve is poised to raise its interest rate.

Some Fed members recently said that the U.S. central bank could consider raising the rate up to three times (by at least 75 basis points in total) by the end of 2016. Considering that there remain only five monthly Fed gatherings this year, its speed of hike could be very fast.

If this happens, the Korean central bank has no choice but to follow suit so as not to see a massive capital flight. If the BOK also raises its rate at a rapid pace, there is a high possibility that many households will fall into debt payment delinquency as most of the mortgages are based on floating loan rates.

Housing prices are expected to drop when the market rates rise. This is an emergency.