When Bank Negara recently announced that Malaysia’s household debt-to-gross domestic product (GDP) ratio increased to 89.1% as of 2015 from 86.8%, most people grew more anxious.
In fact at 89.1%, Malaysia has one of the highest household debts in the region.
Malaysia’s and Thailand’s household debt to GDP ratios have almost doubled between 2008 and 2015. Thailand’s ratio stands at about 80%. Both governments have since implemented reforms and macro measures to contain this debt, particularly among the lower income group.
Now, the risk stemming from elevated household indebtedness is that private consumption could come under pressure at a time when these countries need domestic demand to drive growth in the face of weak external demand.
Will higher indebtness affect the stock market as people pull their money out to service their loans? In Malaysia, this is already seen in the more moderate growth for household investments in equities and unit trust funds for 2015.
Could the risk of high household debt worsen the economic situation of a country in the event of an economic shock?
Household debt is defined as the amount of money that all adults in the household owe financial institutions. It includes consumer debt and mortgage loans.
A significant rise in the level of this debt coincides historically with many severe economic crises and was the main cause for the US and European economic crises of 2007-2012.
Higher debt supported by higher asset quality
If we were to read Bank Negara’s Financial Stability and Payments System report, it actually points to higher asset quality taken up from the household debt.
Bank Negara says that despite the elevated 89.1% ratio, the ability to service debt remains sound.
Bank Negara has over the last few years implemented various pre-emptive macro prudential policies to address the concerns over rising household debt in Malaysia.
In its recently-published annual report 2015, the central bank argues that the risks emanating from high household debt have eased as evidenced by the continuous improvement in asset quality of the domestic banking system, moderation in the pace of unsecured lending and declining share of debt by vulnerable borrowers, defined as those whose monthly income is less than RM3,000.
Also, the growth in household debt continued to moderate during the year to 7.3% (2014: 9.4%).
In particular, there was a moderation in loans for the purchase of securities (2015: 1.7%; 2014: 12.3%) and the purchase of non-residential property (2015: 8.1%; 2014: 10.6%).
In a recent interview with StarbizWeek, Bank Negara governor Tan Sri Zeti Akhtar Aziz said that while debt is growing faster than income, but assets are more than two times liability.
In terms of quality of debt, the non-performing loan ratio is at 1.5%, meaning that there are not many loans that are turning bad and the people who borrowed can afford to borrow.
Another important factor, housing loans – the largest component of household debt at some 49% – expanded at a slower pace of 11.9% in 2015 compared with 13.3% year-on-year in 2014.
“We cannot deny that 89% is definitely high. It needs to be contained. A level of 60% would be a lot safer. For now though, as long as we don’t have a recession or a major economic shock, I think we should still be alright,” says independent economist Lee Heng Guie.
Areca Capital Bhd CEO Danny Wong says while 89% is high, the ability to service loans in the future is one of the key considerations to assess the situation. The ratio should not be viewed just as a headline number.
“Will your long-term income be able to repay your long-term debt? Typically as your salary grows higher, the proportion of your debt will eventually be lower compared to your income,” says Wong.
He adds that higher debt levels in countries with more rapid growth is more palatable.
In Malaysia, for example, there are the various transformation efforts to increase individual household income. Such measures could bring down one’s debt level in proportion to one’s income.
“The other thing is what is the debt used for? Is it a quality asset? If debt is used for financial investment or a property, or to pay for an education, then it is fine. If it is used for consumption, to maintain one’s lifestyle or to buy a luxury car, then that will lead to trouble,” he said.
“We are in a situation where our expenses are rising. Do we continue waiting to buy a property? Prices will just keep going up. So sometimes, we just have to lock in that certain cost. If our salaries or even our normal increment can grow faster than the loan amount of an asset, taking on the debt is fine. The financial asset that we purchase will also increase in value,” says Wong.
Lee adds that Bank Negara does not want to encourage a debt-fuelled economy.
“I agree that some debt is good, especially if you take on debt for an investment. However we do not want to be in a situation where if Bank Negara lowers interest rate, people use it as a leeway to further stretch their balance sheet. We need to contain those debt levels,” says Lee.
Lee adds that while loan levels are growing at a slower pace, it is nonetheless still growing.
“The main thing is to tackle the problems the lower income group is facing – those earning below RM3,000. With the high cost of living, GST and the weak ringgit, people in this group are suffering. They will continue to be leveraged and will surely need to draw down from their savings, if there is any.”
“With the current environment, we would not know if the lower income group goes to informal channels to borrow money. This would in fact mean more debt. To contain this problem, we will need to monitor the lower income group very closely,” says Lee.
Interest rates remain low
For debt to become a problem, interest rates will have to rise to much higher levels and stay there for a long time.
Interest rates are now also at historic lows. In fact, the world is entering a scenario of negative interest rates.
In other words, the present debt costs are cheap and very manageable.
While that is good for now, interest rates will eventually go up. The Fed will definitely start normalising interest rates in the second half of the year.
“Unless we see some gross monetary policy errors that could lead to hyperinflation, rates will likely rise, but at benign rate hikes. Also, as the economy grows, this will shrink the individual’s interest payments as a percentage of GDP,” said one economist from a local house.
Alliance Bank chief economist Manokaran Mottain points out that households that are highly leveraged have more than half of their loans in fixed-rate financing. This reduces the sensitivities to changes in financing cost.
The leverage levels of higher-income groups have remained stable at three times.
Nonetheless Manokaran feels that a level of 89% calls for caution.
“As long as people have a steady income and there is no major crisis, we can weather this. But we need to take proactive measures to ensure something similar to the US subprime crisis does not happen,” says Manokaran.
He adds that the headline number of 89% is partially contributed by the fact that the Malaysian GDP also grew slower last year.
Last year, lower commodity prices, weaker external demand and poor sentiment sent the GDP growth down to 5% from 6% in 2014. Moody’s is seeing GDP growth at 4.4% this year while Bank Negara is projecting 4%-4.5% growth.
The economist adds that debt doesn’t prevent growth in an economy which is being pump primed or when it is private-sector-led.
“Economic growth leads to shrinking debt loads relative to GDP and makes the debt more affordable in the future,” he says.
Growth, in basic economics, is a function of four variables: resources, labour, capital and technology.
Managing debt
“When there is growth, a high debt load doesn’t matter as long as it is affordable. A growing economy makes it fairly easy to manage debt,” says the economist.
He points out that while the headline figure of 89% looked scary, a lot of the people who were highly indebted could more than afford the loans they were paying.
“Close to 50% of these debts are tied to the property market, and were bought over the last 4 to 5 years when developers interest-bearing scheme (DIBS) were the rage. Since 2010, Bank Negara has had stringent rules when assessing whether a borrower is qualified for the loan. If a person has qualified for a loan by a Malaysian financial institution, it is very likely that he can more than afford the loan, says the economist.
He adds that many of the property buyers who bought properties during the DIBS era, had more than one income.
“These are relatively wealthy people with passive incomes from other investments. They are not just depending on their salary. So while their household debt to GDP ratio may look high, these people are actually financially strong and have a strong ability to service their loans,” says the economist. - The Star
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