According to the Bank Negara’s Annual Report 2010, Malaysia’s household debt at end of 2010 was RM 581 billion or 76% 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% 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 9.1% in 2006, rose to 49.0% in 2009 and dropped slightly to 47.8% 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 % for Malaysia, one of the highest in the world; above that of Singapore at 105.3 %, USA at 123.3 % and Thailand at 52.7% 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 installments.
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%) and household debt (7.1%) has been faster than GDP growth (5.4%). In 2010, household debt rose by 12.5% whilst GDP growth was 7.2%. 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 U.S. During the same period, personal consumption grew supported by significant rise in household debt that reached 100% 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%, 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% 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.
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