News of the bailout of the US mortgage giantsFannie Mae and Freddie Machit South Korea hard, with its share market plunging to a low for the year of 1,489.86 points. Economists and investors expressed concerns that South Korea may confront a combination of economic downturn, asset deflation, rising interest rates and inflation.

South Korea was in the midst of an aggressive expansion of bank lending when the international credit crunch hit in 2007. Small and medium enterprises (SMEs) and households are heavily indebted. Bank loans to SMEs stood at 398.9 trillion won ($US394.1 billion) in May, up 28.9 trillion won from December, while the overdue rate has increased to 1.3 percent in March, up from 1 percent in December.

Household debt has been growing even faster than the US. The total grew by 210 percent from 2001-2006, compared with 190 percent in the US for the same period. Total home mortgages reached 229 trillion won ($226.25 billion) in June, up 35.5 percent from 169 trillion won ($166.9 billion) at the end of 2004.

Although the housing prices in South Korea have not experienced a dramatic decline, rising mortgage interest ratesup 0.25 percent from Aprilare placing millions of families under enormous stress and raising the prospect of US-style home foreclosures. An unnamed Bank of Korea (BOK) official told the Korea Times on July 16 that it was still too early to talk about asset deflation. However, if asset values drop by an additional 20 to 30 percent, chances are that the country will face another credit crisis, he said.

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