Rising Debt From Mom-and-Pop Businesses Adds to Korea’s Woes (1)

(Bloomberg) -- Swelling debt at the rising number of mom-and-pop businesses in South Korea is adding to the challenges of an economy that is already burdened by record household borrowing and the restructuring of its once-mighty shipyards.

Debt of the self-employed has surged 9 percent in the past 12 months, to an all-time high of 256 trillion won ($225 billion), according to the Bank of Korea. That makes it more than one-third the size of household loans, which themselves may also contain some hidden borrowing for small enterprises, according to the central bank.

What most worries policymakers in Korea is that only 30 percent of the small businesses survive more than five years, and many of the people starting these enterprises have done so after being laid off because of corporate restructuring. They often lack business skills and are trying to find a way to make ends meet and save enough for retirement.

BOK board members noted the need to monitor small business debt at the September policy meeting, minutes show. Lawmakers from both the major parties have recently warned of rising default risks of mom-and-pop ventures due to high competition and the slowing economic growth rates.

“Many of those who start small businesses in Korea are middle-aged workers who left companies, either voluntarily or unwillingly, and are unprepared,” said Jun Sung-in, an economics professor at Hongik University in Seoul. “A lot of them fail in a year or two. They suffer more than those employed at companies during economic slowdown.”

Economists forecast South Korea’s economy to grow 2.6 percent this year and 2.7 percent in 2017, which is lower than projections by the central bank and the government. This rate of expansion, while better than most developed economies, compares with average annual growth of 3.6 percent in the previous 10 years.

Loans to mom-and-pop businesses are similar to household debt in that the repayment burden falls on an individual, not a company. Yet they have not been as strictly screened as they could be because so far default rates have been declining. This downward trend may change as the self-employed see their income and profitability deteriorate, according to Jean Lim, a research fellow for Korea Institute of Finance.

The number of self-employed rose by 86,000 in September, a second monthly gain after years of steady decline, data from statistics office show. The recent increase was led by small retailers and restaurants, and was concentrated in Gyeonggi province near Seoul and Gyeongsang province at the southern end of the peninsula, where many ailing shipbuilders are based.

Daewoo Shipbuilding & Marine Engineering Co. and Hyundai Heavy Industries Co. -- which have been going under restructuring and lay-offs -- both have operations in Gyeongsang.

Korea Institute of Finance said in a report this month that the ratio of financial debt versus disposable income is higher for the self-employed, at about 146 percent. For regular employees it is 96 percent. The increase in small businesses’ debt is led by owners in their 50s and 60s, according to the report.

Opening a fried chicken joint is a common choice for many South Koreans who have been laid off or are trying to get by in retirement. The start-up costs are relatively low and these business doesn’t require sophisticated skills, though competition can be fierce.

An analysis by the Seoul Metropolitan Government earlier this year showed the ratio of businesses shutting down within three years was highest for fried chicken shops, followed by bars and coffee shops. Small businesses in Seoul closed, or shifted categories, after an average of only 2.1 years, data show.

According to data by the Small and Medium Business Administration, of those who started their own small businesses in 2008, only 60 percent managed to survive past the first year, and only 29 percent were still running businesses after five years.

Loans to small businesses are offered at higher interest rates than those to households, and have been profitable for banks, which partly explains the fast increase, said Shin Hyun-yeol, head of the BOK’s financial stability analysis team.

(Updates with report by Korea Institute of Finance in 10th paragraph.)

To contact the reporter on this story: Jiyeun Lee in Seoul at jlee1029@bloomberg.net. To contact the editors responsible for this story: Brett Miller at bmiller30@bloomberg.net, Peter Pae

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