Household Debt: Watch out!

INTEREST rate hikes appear to be the theme song that most central banks are dancing to in 2022, with rate hikes increasing in intensity - especially in July.

On July 13, the Bank of Canada announced a 1% increase in its main interest rate.

Such aggressive tightening of monetary policies were first seen among the G7 countries, and this is the largest increase in 24 years.

More recently in the United States, the Federal Reserve announced another 75 basis points increase to the Fed funds rate, the fourth rate hike that Fed Chairman Jerome Powell has announced since the start of 2022.

Back in Malaysia, in the May and July Monetary Policy Committee (MPC) meetings, Bank Negara Malaysia raised the Overnight Policy Rate twice by 25 basis points, effectively bringing the benchmark interest rate to 2.25% from 1.75% seen earlier this year.

The decisions to tighten monetary policy were mostly made on the pretext of rising inflationary pressures brought about by disruptions in food supply chains and higher energy prices caused by both the pandemic as well as the Russia-Ukraine conflict.

Another reason frequently cited by central banks to justify their rate hikes is that their respective economies have shown signs of recovery, backed by stronger demand following the opening of borders to tourists and normalisation of economic activities post-pandemic.

One of the few central banks which is dancing to a different tune is the People’s Bank of China. Instead of tightening the country’s monetary policy, the central bank of the world’ssecond largest economy cut its main mortgage interest rate by 15 basis points to 4.45% in May.

On top of that, it also announced liquidity injections into specific sectors adversely affected by the Covid-19 pandemic as President Xi Jinping presses on with the Zero Covid policy.

A hike in a country’s interest rate could have many impacts on people on the street. By increasing the interest rate, a central bank generally expects people to increase their savings to take advantage of the higher interest payable to depositors, hence reducing spending and subsequently easing inflationary pressure.

Besides, spending by consumers and expansion by businesses would also be curtailed given the higher borrowing cost in a high interest rate environment.

One particular huge impact that interest rate hikes would have on a country’s residents is the higher debt obligation for variable-rate loans, particularly mortgages. A hike in the interest rate means that loan borrowers now need to fork out more money from their pockets to meet the higher interests charged on their mortgages.

As at December 2021, Malaysia’s household debt to Gross Domestic Product (GDP) ratio stood at a whopping 89%, becoming the nation in South-East Asia with the second highest household debt to GDP number, trailing Thailand which has a household debt level of 90%.

With mortgages making up the bulk of household debt, Bank Negara Malaysia’s moves in normalising interest rates, though not as aggressive as those seen in advanced countries like Canada and the U.S., risk pushing these loans into the non-performing region.

Meanwhile in China, household debt amounted to just 60% of GDP in 2021 vis-a-vis 89% in Malaysia and 106% in South Korea.

Though the composition of China’s household debt is similar to that of Malaysia’s, with debt concentrated in mortgages, the current downturn in China’s property market would translate into lower household debt ratio in the coming quarters.

This, coupled with the central bank’s recent move in lowering mortgage interest rates and pledge to maintain an accommodative monetary policy stance, would give consumers and loan borrowers in China a breather in weathering the storms that are sweeping through the global economy right now.

The rakyat as well as the central bank should be cognisant of the fact that the B40 group is the most affected by rising costs of living as well as having mortgage repayment as their main debt obligation as core inflation, calculated by excluding prices for goods and services that are subject to fluctuations that are transitory in nature, rose at a yearly rate of 3.4% in June 2022, the most since March 2016.

Another rate hike by Bank Negara Malaysia seems imminent in the September MPC meeting.

Consumers and loan borrowers should brace for more challenging times ahead. In the face of rising prices of essential goods and possibilities of further hikes in the interest rate, the Rakyat, especially those in the lower income group, are urged to better manage their finances so as to avoid falling into a debt spiral.

Dr Liew Ping Xin is an Assistant Professor at Universiti Tunku Abdul Rahman. The views expressed here are entirely the writer’s own.

The SEARCH Scholar Series is a social responsibility programme jointly organised by the Southeast Asia Research Centre for Humanities (SEARCH) and the Centre of Business and Policy Research, Tunku Abdul Rahman University College (TAR UC), and co-organised by the Association of Belt and Road Malaysia.