Avoiding Japan’s ‘lost decades’ – The Korea Times

By Peter S. Kim

Peter S. Kim

Since the Korean government announced its Corporate Value-Up program in January, the Korean stock market has risen by 12.3 percent, primarily due to foreign investor buying. The program is designed to unleash companies’ corporate valuation potential to make them more attractive to investors via numerous reform measures. For decades, Korean companies have been under the shadow of the Korea Discount, which attributes Korea’s persistent under-valuation to a lack of corporate transparency, low dividends and weak rights afforded to minority shareholders.

One of the initiatives includes numerous taxation reforms, which the National Assembly will review. With global investors considering taxation policy changes a crucial measure, this issue will be in focus ahead of the upcoming elections. Since the opposition left-wing party currently holds the majority of the parliament, the election outcome will be a key swing factor for the reform’s momentum.

Recently, Japan’s capital market reform plans have been in the spotlight. Japan’s efforts to address its structural problems began belatedly with the late former Prime Minister Shinzo Abe’s economic policy, “Abenomics,” which had been hampered by limited support until recently. Last year, the Tokyo Stock Exchange (TSE) rolled out a comprehensive reform plan with great effect. The index has risen more than 47 percent over the past 12 months and garnered big attention from global investors who were seeking a viable alternative to China. One key mantra of the TSE’s plan is “asset-based income,” which is designed to break Japan’s growth spiral by facilitating the shift to investments from savings.

Korean policymakers have taken notice of Japan’s reform efforts but with even more urgency as Korea’s economic growth is declining faster than that of Japan, albeit from a higher base. The impact of the demographic cliff on future economic growth is best depicted in Korea’s dominant pension system managed by the National Pension Service (NPS). The NPS forecasts that Korea’s pension system will be completely depleted by the year 2050, revised from an earlier forecast of 2060. If the birthrate and returns on financial assets do not improve in the coming years, the pension system could potentially collapse even sooner.

With the demographic cliff steepening and export industries fading, revitalizing the financial market is one remaining growth channel available to Koreans. This has made the Corporate Value-Up program both an economic and political issue. In particular, millennials and Gen Zers are becoming increasingly important voting blocs. Unlike the previous generation who enjoyed decades of robust job and income growth turbo-charged by the booming export sector and a bull market in residential property, they are seeking sustainable and stable returns on financial products. Returns on financial products, including stocks and bonds, however, have significantly lagged behind high-rise apartments. Korean equities, in particular, have historically not only underperformed residential property but also have been very cyclical and volatile.

For Koreans, a long love affair with residential property is gradually coming to an end in line with the declining population. With almost 75 percent of assets in residential property, Koreans have one of the highest concentrations of assets in domestic property. As real demand for real estate wanes in line with deteriorating demographics, financial assets will become increasingly more important in the future. Much like the “Mrs. Watanabe” phenomenon in Japan when retail investors went abroad to seek returns on financial assets, it is time for “Mrs. Kim” to seek healthy and sustainable returns on financial products.

Real demand for real estate will decline, and investment demand for property will also decline in most parts of Korea. The national price average is slowing quickly as areas outside Seoul face the brunt of deteriorating demographics. Given restrictive property market regulation and higher interest rates, even the most popular residential areas like Gangnam could see significant pressure as the population continues to dwindle. With demand for apartments gradually unwinding, financial assets will see rising and sustainable demand. The rush already started to take root during the pandemic, with Korean investors now on a structural trend of buying financial assets both at home and overseas.

Since the Asian Financial Crisis more than 20 years ago, ballooning household debt has been a key concern of Korea’s financial system. Many investors even cited it as the source of the country’s next debt crisis. However, I have maintained that the concerns are overblown as long as Korea’s property market does not crash since almost 75 percent of the household debt is collateralized mortgages and jeonse. Rising household debt has been driven not only by the desire to own a home but also by investment demand that was attracted to the significant outperformance of residential property, particularly high-rise apartments, relative to all other financial investments.

One unanticipated benefit of the demographic cliff could be the natural unwinding of household debt as ownership of residential property declines. Earlier this year the Korean government announced long-term targets to control the annual growth rate of household debt to within the current GDP growth rate and to maintain below 100 percent of GDP by 2027. Korea’s household debt to GDP ratio is estimated to have been 100.8 percent at the end of 2023, and local press reports the government aims to reduce household debt to 70-80 percent of GDP by 2030.

Rather than introducing policies that forcibly suppress household debt by making residential property unattractive, a more effective measure would be to promote financial products as an attractive alternative. Korea can learn a lot from the decades of pain experienced by Japan and, for a rapidly aging population, shifting from real estate to financial products as the core investment asset should be a focus. Hence, considering the structural challenges facing the Korean economy, the Value-Up program should not be dismissed as just another election theme but regarded as a timely and urgently needed transition to becoming a developed economy.

Peter S. Kim is managing director at the KB Financial Group.

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