Addicted to debt


MALAYSIAN households face a pivotal moment.

As the economic environment turns against their favour on the back of rising interest rates and higher cost of living, many households in the country will find themselves in a vulnerable position because of their high level of indebtedness.

Further setbacks for many Malaysian households are their limited savings and relatively low income – a situation that will surely exacerbate their vulnerability to various shocks such as a loss of job or health emergencies. For instance, the decline in the prices of commodities such as crude palm oil and rubber is already hitting the livelihoods of rural households hard.

Previous studies suggest that Malaysians have racked up so much debt that most of them have been spending a large portion of their monthly income just to pay back their loans.

Last year, the debt-service-ratio of households in Malaysia stood at 43.5%, which means households in the country on average use more than two-fifths of their monthly disposable income to service their loans. What’s even more disturbing is the estimated debt-service-ratio of civil servants in the country at around 60%.

The acceptable level of debt-service-ratio is up to 30%, implying that a sound financial position is when a household is not spending more than one third of his income on debt repayment.

High consumerism, low wage

A recent study by Khazanah Research Insitute (KRI) on the state of households in Malaysia also paints a worrying picture.

The report, entitled simply “The State of Households”, shows that consumerism is high in Malaysia, with many households owning discretionary durable goods such as television, washing machines, refrigerators, cars and motorcycles, despite their relatively low-income levels.

Most households in the country cannot actually afford to buy all those high valued items with cash; so, they are doing so on credit.

“The wealthiest pay by cash; the better-off choose credit based on interest rates and the least well-off choose based on what is on offer and the instalment payments they can afford,” KRI says in its report.

“But the reality is that the buyer pays more than a quarter of the purchase price in interest payments. The problem is most acute with consumer durables – rates are almost 50% per year,” the research arm of sovereign wealth fund Khazanah Nasional Bhd says of the impact of “ansuran mudah” (affordable instalment schemes) on households.

Official statistics show that the median household income in Malaysia currently stands at only RM3,626 per month.

For the low-income group, who makes up the bottom 40% of Malaysia’s society, the median household income is only RM1,852 per month, while that for the middle 40% is at RM4,372.

The better off, who make up the top 20% of the country’s households, earn a median income of RM9,796 per month.

KRI’s study gives further insight into the state of household income in the country: despite Malaysia’s rapid economic growth in the last two decades, 74% of the country’s households are still earning less than RM6,000 a month. Those who earn less than RM4,000 a month make up 55% of the country’s households, while 23% of households in the country make less than RM2,000 a month.

At the individual level, KRI says, the median monthly salaries and wages is only RM1,700.

This, it notes, is consistent with data from the Employees Provident Fund (EPF), which shows 62% of the fund’s active members earn less than RM2,000 per month, and 96% earn less than RM6,000 per month.

KRI’s study confirms the notion that lower income groups have a higher propensity to consume, and less propensity to save.

“Increasing their incomes may lead to more consumption and higher growth. If their consumption falls because they can no longer service their debt due to rising costs (as happened in the US in their Great Recession), it can be very bad for the economy,” the institute points out.

Economists tell StarBizWeek that the relatively low-income level of many Malaysian households is a constraining factor to make private consumption, a main component of gross domestic product (GDP), a driver of growth.

While the availability of cheap credit amid low interest rates in recent years have encouraged more private spending, which ultimately helped boost the country’s economy, debt-driven private consumption is not sustainable.

Economists explain that households who have borrowed too much in relation to their income may eventually have to trim their spending, and this could potentially drag economic growth. Conversely, they note, households’ debt burdens would become lighter if their incomes could rise at a faster pace, and that would be a positive factor to the economy.

KRI’s study, however, finds that wage growth in Malaysia has consistently lagged behind productivity growth. It notes the trend is symptomatic of the lack of bargaining power of low-skilled labour and the country’s over-reliance on low cost as competitive advantage.

Potential crisis

As at the end of 2013, Malaysia’s household debt is valued at 86.8% of the country’s GDP, which is a substantial increase from 60.4% of GDP in 2008.

While economists have long voiced their concern of the potential risks of Malaysia’s high household debt to the country’s growth, Bank Negara has brushed aside such concerns, saying that household debt in Malaysia remains at a manageable level as household financial assets have been expanding in tandem.

According to the central bank, total household assets in Malaysia had been growing at an average annual rate of 10.4% over the last 10 years to 321.6% of GDP at end-2013. It believes the high level of household financial assets could mitigate macro risks.

Although KRI’s study finds that households earning less than RM3,000 a month account for a “relatively low” share of the total household debt in Malaysia, the institute points out that borrowings by this low-income group are proportionately higher than the rest at seven times their annual income.

“The pressing concern is how much debt low-income households have taken on relative to their ability to pay. They spend most of their income and have little savings, making them susceptible to financial stress should interest rates and inflation continue to rise,” KRI highlights.

As Mark Billington, the regional director of the Institute of Chartered Accountants in England and Wales (ICAEW) Southeast Asia, puts it: “Allowing credit growth to offset weak wage growth in lower earnings groups may ultimately raise the number of non-performing loans. That, in turn, could result in increased risks of another financial crisis.”

In conjunction with the release of ICAEW’s latest quarterly “Economic Insight: South East Asia”, Billington says domestic consumption as a share of GDP in most countries in the region is still considered low by international standards.

He notes that while the retail banking sector has facilitated a gradual increase in domestic consumption, which helps to rebalance Asean economies between production for export and for domestic consumption, he cautions economies with already high consumption rates to take care to avoid artificially raising the standard of living (through debts) due to the potential danger of triggering a crisis.

To Bank Negara’s credit, though, efforts have been taken to control the increase of household debt and financial imbalances in the country. Recent years have seen the central bank implementing various macro-prudential measures, including stricter loan guidelines.

In addition, Bank Negara has started the process of interest-rate normalisation after a prolonged period of a low-rate environment. In July, the central bank raised the overnight policy rate (OPR) by 25 basis points to 3.25% - the first increase in three years – stressing the need to address destablising financial imbalances in the economy.

Cheap money

The International Monetary Fund, World Bank and HSBC are among some of the international organisations that have warned Malaysia over the high level of its household debt.

But obviously, the problem is not unique to Malaysia, as several countries in the Asian region have also seen a dangerous spike in household debts in recent years, thanks to the availability of “cheap money” as central banks all over the world cut interest rates to boost their economies to counter the impact of the 2008/09 global financial crisis.

As it stands, Malaysia’s debt-to-GDP-ratio is the highest in Asia. Trailing closely behind is South Korea at 86%, followed by Thailand at 84% and Taiwan at 82%.

Debt-fuelled consumption in many Asian economies may have helped boost growth in recent years. But as the current economic environment shifts, with central banks starting the tightening cycle amid a highly uncertain global economy, many countries in the region may well be facing a new danger.

Unsurprisingly, therefore, the theme of late is whether a new financial crisis is brewing in Asia because of the region’s high debt levels.

Optimists will dismiss such notion, but it will be foolhardy to ignore the region’s exposure to such risks, for when the next crash comes, many households indeed will be hit hard.