APRIL 26 — According to Bank Negara’s Annual Report 2010, Malaysia’s household debt at end of 2010 was RM 581 billion or 76 per cent of GDP (Gross Domestic Product). The Bank claimed that the household debt is still manageable because of income growth, high levels of savings and favourable employment opportunities.
However, if we look at household debt from the point of disposable income then the picture painted is worrisome because it reveals that households are spending about half of their income to pay off their debts.
Where household debt is concerned, the ratio of household debt to household disposable income and the debt service ratio (the ratio of the debt payments to disposal income), are more accurate indicators of household debt sustainability because the ability to service debt is directly related to disposable income rather than to GDP.
Household Debt Service Ratio
Generally a debt service ratio of 30 per cent is acceptable, i.e. one third of a household income is used to pay off debt (principal and interest). However, the Malaysian household debt service ratio was 39.1 per cent in 2006, rose to 49.0 per cent in 2009 and dropped slightly to 47.8 per cent in 2010. This means that on average almost half of a household’s income goes to repaying debts. Thus after paying off the debt there is not much left to spend on food, transport, education, and for emergencies. Should the breadwinner fall sick or lose his job, the family will find it hard to make ends meet and loans may be defaulted.
Household Debt to Disposable Income
Looking at the problem from the ratio of household debt to disposable income, this ratio is 140.4 per cent for Malaysia, one of the highest in the world; above that of Singapore at 105.3 per cent, USA at 123.3 per cent and Thailand at 52.7 per cent in 2009. This means that the loans taken by each household in Malaysia is on average 1.4 times more than its household income. Since both the household debt service ratio and the household debt to disposable income are average figures, in reality it will be those in the lower income group who are at greater risk of not being able to pay off the monthly instalments.
Spending using borrowed funds can boost economic growth but it can also slow the economy when households are forced to restrain spending in order to service their loans. Thus there are unfavourable policy implications and economic impact when household debt keeps rising.
Policy Implications of Rising Household Debt
First, it restricts the government’s monetary policy. Low interest rates have led to substantial increase in housing loans and house prices beyond sustainable levels. House prices to household incomes in major cities of Malaysia have over-stretched the debt servicing capacity of the average household. Should government increase interest rate, it would add further burden to their debt servicing ability.
Secondly, the growth in personal consumption driven by debt, rather than by income growth, is not sustainable and will be derailed with an increase in interest rates and inflation. Between 2005 and 2009, annual growth in personal consumption (7.7 per cent) and household debt (7.1 per cent) has been faster than GDP growth (5.4 per cent). In 2010, household debt rose by 12.5 per cent whilst GDP growth was 7.2 per cent. Therefore, unless there is a rise in productivity, wages, and household incomes, this trend is not sustainable and can end up in a debt bubble like what happened in the U.S. Between 1975 and 2007, despite rising productivity, average wage stagnated causing a divergence between the two in the US During the same period, personal consumption grew supported by significant rise in household debt that reached 100 per cent of GDP. This created a debt bubble that finally imploded in 2007.
Thirdly whilst today’s non- performing loan ratio is low at 2.3 per cent, Bank Negara should not take too much comfort in this. This ratio can easily balloon when interest rates rise and growth falters leading to household insolvency.
The government’s efforts to curb the problem of rising household debt should therefore be directed to those sectors that make up the most debt.
Composition of Household Debt
The biggest portion of the Malaysian household debt goes to paying off housing loans followed by passenger car loans, personal use, securities purchase, and credit cards.Malaysians take on increasing amount of housing loans because of rising house prices, low or negative interest rates, and speculative activities. Banks and other financial institutions have encouraged borrowing by offering low down-payment, some as low as 5 per cent of the value of the property, while developers provide marketing incentives in the form of payment of certain transaction costs and interest — “free” financing during the construction period.
There are strong indicators to suggest that house prices and ability to service housing loans have been overstretched in Malaysia. A ratio of house price to household income of 3 to 4 times is internationally acceptable but this ratio has risen to over 6 times and over 8 times in Kuala Lumpur and Penang island respectively.
Next to housing loans, car loans form the second largest category of household loans. This is due to Malaysia’s misguided national car policy encouraging car ownership, to support Proton at the expense of a good public transport system. As a result, ordinary Malaysians are burdened with significant car loans that consume a large part of their income. In fact, car loans are stretched over a long period to enable borrowers to pay off their loans, such that the cars become obsolete no sooner when the loans are fully repaid.
Recommendations
Thus the government needs to:-
• Start a public housing policy that provides affordable housing, particularly in urban areas, to people below a certain level of income. Tighten mortgage rules to cool the property market by, for example, increasing the minimum down payment; reducing the maximum term of the housing loan, and increasing capital gains tax to discourage speculation.
• Tighten the rules for car loans by, for example, increasing the deposit and reducing the term of the loan. Implement a first class public transport system to reduce dependence on private transport
• Stop advertisements for loans and credit cards that are not transparent about the costs involved, thus seducing consumers to sign up for them.
Finally, we are also equally worried about the social consequences on families having high household debts. They can lead to stress, depression, mental problem, suicides and may cause family break-ups.
* The writer is the president of Consumer Association of Penang.
It is actually the predominant belief that wages and salaries rise before aggregate price levels in the economy and thus during periods of rising inflation, real wages are always increasing. However, economic history has proven over and over again that real wages actually decrease during periods of rising inflation. Nominal incomes do increase, but this is merely a response to the inflation that has already been created.
The essence of this folly is that modern economists don't have a firm grasp on the mechanics of inflation. At the most basic level, inflation comes from too much money chasing too few goods. The battle against rapidly rising inflation always has its genesis from a central bank that prints money in order to monetize the nation's debt.
And because the central bank typically only gives this new money to the nation's creditors -- half of which aren't Americans -- the money created is never evenly distributed into the wages and salaries of the people. It goes first into the hands of those bondholders who receive interest and principal payments. In addition, the rapid expansion of the money supply causes the currency to lose value against hard assets and foreign currencies. Nominal wages and salaries eventually respond to soaring commodity prices and a crumbling currency, but always with a lag that causes their purchasing power to fall relative to other asset classes. Have you ever tried to ask your boss for a raise simply because living expenses cost 10% more than a year prior? As you are laughed out of the office, you can see the wage lag in action. Recent economic data provides clear proof that the "wage-price spiral" alleged by Keynesian economists is plainly wrong.
The Consumer Price Index (CPI) has now increased for nine consecutive months. It increased by 0.5% in March from February and is up 2.7% year-over-year. The YOY increase in the prior month was 2.1%. It appears the increase in consumer prices is accelerating quickly. Meanwhile, in the last 12 months, the U.S. Dollar Index has lost 8% of its value against a basket of our 6 largest trading partners. The dollar has also lost 29% of its value since April 2010 when measured against the 19 commodities contained in the CRB Index. If you needed more evidence of the dollar devaluation, producer prices are up 5.8% and import prices surged 9.7% YOY.
So there's your inflation. But was it caused by rising wages and full employment? The unemployment rate has dropped a bit from 10.1% to 8.8% -- but this is mostly due to discouraged workers dropping out of the labor force altogether. However, even if the decrease came from legitimate employment gains, it would be hard to argue that an 8.8% unemployment rate would put upward pressure on wages. And, in fact, it hasn't. Real average hourly earnings dropped 0.6% in March, the most since June 2009, after falling 0.5% the prior month. Over the past 12 months they were down 1%, the biggest annual drop since September 2008!
The conclusion is clear: rising wages can never be the cause of inflation.
Alas, there is a predictable path for newly created money as it snakes its way through an economy. It is always reflected first in the falling purchasing power of a currency and in the rising prices of hard assets. That's because debt holders move their newly minted proceeds into commodities to protect against the general rise in price levels and as an alternate store of wealth. Food and energy prices have a higher negative correlation to the falling dollar than the items in that exist in the core rate. They are the first warning bell in an inflationary period, which may be exactly why they are left out of the headline measure.
Nominal wages and salaries eventually rise but always slower than the rate of inflation, causing real wages to fall. If rising wages increased faster than aggregate prices, inflation would always lead to a rise in the living standards. Is that what we've seen in Peron's Argentina or Weimar Germany? The reason why the unemployment rate soars and the economy falls into a depression is precisely because the middle class has their discretionary purchasing power stolen from them.
Mark my words: if the Fed and Obama Administration place their faith in stagnant incomes to contain inflation, they will sit idly by while the country collapses in front of their eyes. Because of their medieval understanding of economics, these central planners are going to bring us right back to the Dark Ages.
Michael Pento is the Senior Economist for Euro Pacific Capital
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