A surge in housing prices in recent months has put Korea's central bank under the spotlight, and has raised speculation that it might hike interest rates to slow any speculative bubble. Between April and August, housing prices climbed for five consecutive months, according to data collected by Kookmin Bank.
Property prices have bounced back from a slump in the immediate wake of the Lehman Brothers collapse in September 2008, and Tim Condon, chief Asia economist at ING, wrote in a September 28 report: "we think that the Bank of Korea (BOK) views increases of more than 1% [month-on-month] in the overheating-prone areas like Gangnam [or Kangnam] as a warning sign".
The BOK has kept its benchmark interest rate unchanged at a record low 2% since February, having slashed it by 3.25 percentage points since October 2008. But market determined certificate of deposit (CD) rates, to which most housing loans are tied, rose more than a quarter of a percentage point between August and September.
But as it made clear in a monetary policy press conference in September, the BOK watches asset prices closely. And although the governor, Lee Seong Tae, stressed that there were no reasons for interest rate hikes based on conventional macro indicators, such as output and inflation, the central bank might raise the policy rate if asset prices, in particular housing prices, continued to rise, he said.
Towards the end of September, the local press reported that a BOK paper to parliament indicated it was ready to hike interest rates to cool the property market.
Not a bubble, just a recovery
However, Goldman Sachs' Korea economist, Goohoon Kwon, argued in a September 30 report that, "housing price data do not support the notion of a housing price bubble when compared to the US, historical trends and the 1997-1998 financial crisis".
Despite a 24% increase in nation-wide housing prices since the 1998 trough, current levels are still 18% below their 1986 levels in real terms, and the bounce "reflects a recovery from the 1997-1998 crisis".
And a headline-grabbing 70% rise in real terms in Seoul apartment prices since 1986 only represents a 2.2% compound annual growth rate - compared with a 5.5% growth rate for the Kospi index of stock prices.
This is in sharp contrast to the US, Kwon pointed out, where metropolitan housing prices doubled in 2005 from their 1987 levels in real terms before losing one-third of their value afterwards. In August prices were still 1.2% lower than in September 2008, and apartment prices in Kangnam, where the biggest price gains were reported, were 1.7 % less. And, he concluded, "the relatively muted housing price increases in Korea are not a coincidence, but a reflection of concerted policy efforts to avert housing bubbles".
The International Monetary Fund (IMF) seems to agree that there are few grounds for worry. In its country consultation report in August, the IMF said, "despite the fast run-up in house prices since the Asian crisis, home valuations in Korea do not on average appear to be significantly out of line with fundamentals". Korea's gross domestic product grew at a rate of 2.6% more in the second quarter than in the first quarter of 2009, the fastest quarter-on-quarter growth among Organisation for Economic Cooperation and Development members. In August the IMF revised its 2009 growth forecast to a contraction of 1.8% from a 3% fall estimated in July.
Its conclusion came after an analysis of house price growth compared to growth in disposable income, short- and long-term interest rates, credit and equity price growth, and changes in the working-age population. As Kwon pointed out too, in terms of housing affordability, the median price-to-income ratio is at a "still reasonable 4.3 times in 2008, marginally up from 4.2 in 2006 - although the ratio is higher, 6.9 in the Seoul metropolitan area".
"Moreover, a look at house prices relative to income over a longer time period shows that they are still more affordable compared to the early 1990s, even for the faster growing districts of Seoul," said the IMF.
It noted that although Korea's house prices have increased by around 25% in real terms since 1999, that is slower than the Asia Pacific average of around 31%.
But, there is some concern that prices in Seoul are inflating too quickly. A 60% increase since 1999 is well above the price increases seen for other metropolitan areas, including Singapore and Hong Kong.
However, the IMF said that the government's recent anti-speculation measures are a step in the right direction.
Pre-emptive Measures
To address a potential re-emergence of upward price pressures in some Seoul neighbourhoods, the authorities recently lowered the required loan-to-value ratios for these areas. In July, the government decided to cap the amount of money home-buyers can borrow to no more than 50% of the value of a residence in Seoul and nearby areas, down from 60%. Banks were told to look closer at incomes when granting loans.
This selective approach is appropriate given the absence of nationwide pressures in the housing market, and could be pursued further if house prices continue to rise in specific areas, the IMF added.
Also, the current economic slowdown is restraining prices as incomes shrink and banks tighten credit standards. The spillovers from the current slowdown are also showing up in a significant jump in the stock of unsold homes and steep declines in construction permits.
"The property market's liquidity is adequate at this point, so the market is likely to remain steady for some period," said Park Jang Ho, head of Citigroup Global Markets Korea. "Recently, the mortgage loan amount has risen to a record high, but government regulation and the possibilities of further increases in the CD rate will act as a hurdle [to further price increases]," he added.
As to the wider relationship between house prices and inflation, and hence by inference the central bank's response, Goldman Sachs's Kwon is relaxed. "We find the impact of housing prices on inflation and inflation expectations weak and unstable," he wrote.
Correlations between inflation and housing prices were mostly negative for the whole of his sample period (1994-2009) in sharp contrast to consistently strong correlations between inflation and the Korean won and US dollar exchange rate. This is in line with numerous studies on inflation in Korea, including by the BOK. "The only period where housing prices mattered for inflation was in 2002-2005, but the linkage seems to have been broken thereafter as housing prices continued to rise but inflation remained tamed along with Korean won appreciation," he argued.
Although, ING's Condon considers the Korean central bank to be "one of Asia's most hawkish", he noted that "the BOK does not want to be the first major central bank to hike rates", and would prefer for Australia's RBA to be the first to stick its head above the parapet.
This article first appeared in the October issue of FinanceAsia magazine.
