The prudent Asian consumer is soon becoming a thing of the past, as households in many countries of the region go on a credit binge, aided by loose monetary and fiscal sops.
The global financial downturn of 2008–09 was a watershed in the evolution of economic theory and policy. It spurred central banks to innovate and led to greater oversight of banking and financial services. It also sparked discussion on the sustainability of growth models driven by debt-fueled consumer spending as in the United States and the United Kingdom. Not only did high household leverage add to the vulnerabilities in these countries, it also aggravated the resulting economic downturn. In contrast, Asia and some parts of Europe escaped the worst of the crisis, arguably due to lower leverage and higher savings. Not surprisingly, criticism from Asian commentators was harsh.1 And they have been quick to suggest improvements to Western capitalism.2 In particular, they showcased the prudent Asian consumer as an ideal alternative to leveraged households in the West.
However, as the world economy chugs along, (albeit in fits and starts) there appears to be an unravelling of the myth of Asian prudence.3 In many countries in the region, households have gone on a credit binge, aided by loose monetary policy and fiscal sops. Although GDP growth benefited as a result, economic risks have increased. Household debt is now at a record high in many Asian economies. For example, as a share of personal disposable income, household debt in Singapore, South Korea, and Malaysia is higher than in the United States before the global credit crisis (figure 1).
The immediate cause of this rising household indebtedness is loose monetary policy post the outbreak of the global credit crisis of 2008-09. The sharp economic downturn in the West forced Asian economies, especially export-driven ones, to turn to their domestic markets for growth. In addition to fiscal stimulus, policymakers unleashed monetary easing and increased sops for consumer spending. While this led to greater contribution of private consumption to GDP growth during 2010–14 (figure 2), it also pushed household debt up sharply (figure 3) in many countries. For example, in Thailand, the ratio of household debt to personal disposable income jumped by an astounding 56 percentage points during 2007–14.
Strong income growth, in turn, helped alleviate poverty and added to the legions of the middle class. This has fueled consumption, with households increasingly using debt for spending.
A number of other factors have likely led to soaring household debt in parts of Asia over the years.
The rise in household debt in Asia has led to a number of complications, including fears of property bubbles, risks to the banking sector, and complications for monetary policy.12
The rise in household debt does not come at a good time for Asian economies. With the Fed likely to raise rates in the near term, Asian currencies could be hit, thereby stoking inflation. Additionally, the rising debt burden of households has come at a time of greater fiscal consolidation in some economies. In Malaysia, for example, the removal of subsidies has forced up inflation. Overall, high household debt, slowing house prices, and higher debt servicing costs (however delayed) will weigh on personal consumption growth in key Asian economies in the near term. In contrast to a few years before, consumers in Asia are slowly waking up to reduced credit access amid slow real income growth. Declining global liquidity due to the September 2014 closure of the Fed’s assets purchases program and a probable rise in interest rates in the United States will add to the discomfort.
Despite challenges, high household debt in Asia does not pose immediate risks for economies. Governments are well-placed to aid households and inject capital into banks should the need arise (table 1). In countries like Indonesia and Malaysia, current fiscal consolidation efforts will help governments to react more decisively to a financial crisis.17 External balances in the region are also healthy, with sizeable reserves in place (table 1) to support currencies in the event of any sharp capital outflow. Also, financial regulations have been beefed up post the Asian financial crisis and the global financial crisis.
Table 1: Government balance and debt, current account, and reserves
So far, policymakers’ response to high household debt and likely property bubbles has been innovative. In addition to tightening credit, policymakers have targeted loan-to-value ratios, put restrictions on the value of loans relative to income, and introduced greater scrutiny of loan applications. On the fiscal side, taxes related to property have been increased and the bar on foreign investors in real estate has been raised (as in Malaysia). Overall, governments are keen to prevent a hard landing in real estate. Trends in Malaysia and Singapore suggest that authorities have so far been successful (figure 8).
The calculation of change in house prices is based on key house price indices for each economy; 2015 figures are forecasts by Oxford Economics.
Problems related to high household debt should be an eye opener for Asian policymakers. Overreliance on credit-driven consumption and its links to the housing market have been demonstrated to be imprudent. Hence, greater oversight is one of the key factors required to keep banks healthy enough to handle a crisis. Monetary authorities in Asia may wish to take a leaf out of the Fed’s book and introduce regular stress tests for banks. Publication of the results and the methodology could enhance the credibility of the process.
Also, policymakers need to note that the success of any shift in the growth model from an export-driven economy to a domestic demand-led one is dependent on a strong domestic private sector, having at its core a vibrant banking and financial services sector that offers a range of savings and investment options. In many Asian economies, households are often caught between low-yielding fixed income deposits and real estate; naturally, many opt for the latter. A more balanced mix of investment in fixed income deposits and real estate could lead to greater efficiency in savings and investment, but it will also enable banks and households to diversify their portfolios.
In many developing and emerging economies in Asia, the calculation of household debt itself is a problem, given low banking penetration and large-scale non-formal lending. For example, although household debt-to-GDP ratio is low at 22 percent in India, limited banking penetration means that a small set of people owes the entire debt. Moreover, not included in the debt-to-GDP ratio is non-formal lending, predominant in rural areas, where the debt burden and servicing costs are higher than in the formal economy.18
Given its large population and an expected spike in middle class numbers in the next few decades, Asian governments also need to take a closer look at their social security systems. Currently, what exists appears to be inadequate and trails social safety nets in advanced economies. A few steps have recently been taken. For example, India is trying to improve banking penetration and channel aid and insurance to low income earners. Singapore is seeking ways to better support low income households, while South Korea is attempting to help highly indebted households. But much more needs to be done. Without a sustainable safety net in place, dealing with indebted households will become more difficult with time.