Prudent no more Household debt piles up in Asia
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.
A twist in the tale
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 fuel that fed the fire
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.
- Rising incomes contributing to higher consumption in Asia. Economic fortunes in Asia have improved remarkably in the past few decades. Over 1990–2014, per-capita income in current international dollar of purchasing power parity (PPP) grew by 8.4 percent a year on an average in emerging Asia; in more advanced economies, the figure was 3.5 percent.4 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. This trend is expected to continue, given that the size of the middle class in the Asia-Pacific region is expected to rise to 3228 million by 2030 from 525 million in 2009.5
- Greater access to credit. Buoyed by the fast-growing Asian market, banks and financial institutions have expanded their services. These include housing loans, personal loans, credit cards, investment accounts, and insurance products.6 Economic liberalization has also made access to financial services easier.7 Moreover, a young population, attracted to new products and aware of global trends, has also pushed up credit-driven spending in many parts of Asia.8
- The lure of home ownership. In Asia, the share of housing in household liabilities has been going up (figure 4). A key factor behind rising housing demand is growing prosperity.9 Home ownership is also ingrained in the cultural psyche; India is a good example of this.10 However, first-time home buyers are not the only ones driving demand and, hence, credit to the sector. Housing is an important investment option as well, given limited financial savings instruments. Real assets, including housing, constitute about 86 percent of household wealth in India and Indonesia, and 50 percent in China; for the United States, it is 30–38 percent based on the inclusion of unincorporated enterprises in the calculation.11
The pitfalls of surging household debt
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
- Concerns about housing bubbles. As consumers directed credit to housing, house prices shot up between 2009 and 2013 (figure 5). The trend was similar in the United States prior to the credit crisis. The price spikes in Asia, therefore, led to suspicions of bubbles, leading authorities to intervene. Thankfully, the rise in house prices has slowed. But, this has hit household wealth, thereby posing risks for consumer spending in the near term. In addition to housing, consumers in many parts of Asia also spent heavily on durables (mainly automobiles) due to greater credit access and fiscal incentives. Now, the story has turned sour in some countries. For example, in Thailand, high household debt and slowing economic activity has dented auto sales and resulted in higher non-performing auto loans.13
- Complications for central bankers. The surge in house prices added to inflation, which was already moving up due to strong credit growth and abundant global liquidity during 2010–12 (figure 6). This created a big dilemma for central banks. They had to tighten policy to prevent bubbles and dent inflation, but had to be mindful of consequent rises in households’ debt-servicing costs. This was particularly true of countries like South Korea and Malaysia, given their high levels of household debt. In contrast, India and the Philippines—both with relatively lower household debt—were able to tighten policy more easily. Fortunately for many Asian economies, inflation has gone down due to low global energy prices, thereby aiding real incomes and reducing the burden on monetary authorities.
- Banks have been impacted. The share of household debt in total debt outstanding in Asia has gone up over the years, especially during 2008–14 (figure 7); similarly, the share of housing has also increased. Unsecured credit has also gone up during this period. For example, the volume of credit card transactions per person in South Korea more than doubled during 2008–14.14 In fact, South Korea is a worrying example of a country with a population that has high unsecured credit usage; per-capita credit card ownership is about five in the country, nearly double the figure for the United States (2.6 in April 2014).15 This surge in unsecured credit in South Korea and other parts of Asia could dent the asset quality of commercial banks, especially when economic activity is slowing. This could potentially reverse the trend of falling non-performing loan ratios in Malaysia, Singapore, South Korea, and Thailand.16 It could also impact the banking sector’s performance. For example, return on assets for commercial banks has already gone down (albeit moderately) in Singapore (1.1 to 1) and Malaysia (1.6 to 1.5) over 2012–14.
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.
Are the risks from high household debt severe enough?
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.
An eye opener
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.