South Korea’s economy is widely expected to post a pick-up in growth this year thanks to a recovery in exports after months of extremely poor performance. However, a recent series of data points to the slump in domestic demand worsening, and the construction sector’s troubles are particularly worrying as project-financing loans remain a key risk to the economy.

Some of the project-financing loans, which surged in line with the booming property market, especially during the previous government’s final years, have begun souring since late 2022 as the housing market entered a correction period in the aftermath of aggressive monetary policy tightening to contain inflation.

Intervention by financial authorities has managed to prevent problems with project-financing loans from triggering a full-blown crisis, but markets and industry experts warn that the issue will continue to pose a threat to the financial markets and the economy as a whole unless the construction industry itself finds a way out of the prolonged slump.

According to the central bank’s latest monetary policy report released last week, South Korea’s real estate project-financing loans stood at an outstanding 134.3 trillion won ($100.94 billion) at the end of September 2023, sharply up from just 92.5 trillion won at the end of 2020. More concerning was a jump in the delinquency ratio to 2.4 percent from just 0.6 percent over the same period.

Continued intervention by financial authorities and major lenders may help the country avoid a crisis for the time being, but the cost of intervention will only increase and harm investor confidence in South Korea’s markets. A more certain solution will be a turnaround in the construction industry itself unless interest rates decrease rapidly.

In the final quarter of 2023, the construction sector’s output contracted by a seasonally adjusted 3.8 percent from the preceding quarter, marking the second-worst decline in two decades, with construction investment plunging 4.5 percent, according to the gross domestic product data. Recent statistics indicate that the troubles have continued into this year.

The monthly business condition index for the construction sector, calculated from the central bank’s monthly survey of companies, dropped to 51 in February from 58 in January, hitting its lowest level in 11 years. The construction sector’s share of total employment also fell to 7.74 percent in February after declining for the past two consecutive years.

While authorities should continue to minimize their intervention in the restructuring process of real estate project-financial loans, they still need to remain vigilant to prevent any sudden event involving big-name companies from sparking turmoil across the financial markets or economy. South Korea already experienced turbulence with Legoland and Taeyoung.

Money market yields have soared since Gangwon Jungdo Development Corp, the developer of the Legoland Korea theme park east of Seoul, missed bond payments in late September 2022. The issue has later been resolved with the help of intervention by financial authorities and the provincial government’s agreement to repay the debt.

The case, although involving political motivation, helped reveal the problems associated with real estate project-financing loans. Then came the failure of Taeyoung Engineering & Construction Co, South Korea’s 16th-largest builder in terms of construction capacity, which applied for a debt restructuring program in December last year due to a liquidity shortage.

The company’s shares, listed on the main board, were suspended last week after it disclosed that its total assets stood at minus 562.6 billion won, indicating a negative net worth in which its outstanding liabilities exceed its assets. Creditors agreed to allow Taeyoung to postpone the repayment of its debts until April 11, but the builder still must secure its own operating funds.

Investors are now worried that Taeyoung may be followed by more failures before the construction industry stabilizes and comes out of the slump. South Korea’s housing price index has fallen 8.4 percent over the past one and a half years since peaking between February and July 2022, according to data from the Korea Real Estate Board.

This decline in prices over a short period of time is significant when compared with historical data for South Korea’s housing market and follows a whopping 16.8 percent gain over the preceding one and a half years. The government keeps saying housing prices are still high and have room to fall further, without providing detailed projections.

The Bank of Korea now looks set to begin lowering policy interest rates from the middle of this year as the inflation has peaked out and is heading down, but its rate cuts are not expected to be fast enough to give an immediate boost to the housing market and the construction industry as a whole.

Until a major turnaround is confirmed, authorities are advised to be extra cautious in making any remarks on the market conditions and to stand ready to take action in a preemptive manner when needed. In that process, the authorities are also advised to be selective in rescuing troubled companies and avoid sparking a moral hazard.

Yoo Choon-sik

Yoo Choon-sik worked as the chief Korea economics correspondent at Reuters and is now a business and media strategy consultant. -- Ed.