When it comes to concerns over household debt levels, Australia is top of the table.
In a recent report, Morgan Stanley identified the developed economies most exposed to excessive household leverage and examined the short and long-term implications.
Given one of the principal causes of the 2008 financial crisis was an excess of debt, it’s not surprising that most developed nations went through a process of deleveraging in the immediate aftermath. What is surprising is that not every country followed this path. Some continued to accumulate debt – to the point where doubts over sustainability are beginning to emerge.
Morgan Stanley recently implemented a new tool for assessing debt sustainability. This Household Deleveraging Risk Indicator identified Australia, Canada, Norway, New Zealand, Sweden and Switzerland as showing cause for concern. Unfortunately, Australia looks the most exposed with a combination of high household and external leverage, weak domestic housing conditions and potential further macroprudential and structural/tax policy adjustments ahead.
The issue with excess debt is that it tends to pull activity forward from the future. So, although GDP and consumption growth is boosted while households are gearing up, this process tends to go into reverse when the necessary deleveraging takes place. Paying down debt leads to below-trend consumer spending which feeds into slower economic growth.
A large driver of the run-up in household leverage over the past decade in certain economies was very strong housing price growth. As such, a reversal in price dynamics is likely to put pressure on households to delever as asset prices fall. Additionally, the housing market is a key channel through which household leveraging and deleveraging can impact economic growth.
After a period of strong house price growth, supply often responds with a surge in residential construction; with household wealth increased, consumers are more willing to spend more and draw down savings; increased value of collateral also assists increases in personal borrowing for spending. With house prices declining, we would expect these factors to reverse and represent a headwind to GDP growth.
The deleveraging of highly-geared households is looking more likely as global financial conditions tighten and broader macroprudential measures slow or even reverse recent house price gains. Canada looks to be starting a benign deleveraging, and Morgan Stanley estimates Australia and Sweden will soon follow suit.
Australia, in particular, looks likely to start deleveraging in 2019. House prices are already falling (and have been for some time) and credit growth is slowing.
Morgan Stanley expects GDP growth to slow from 3.4% currently to a below-consensus 2.7% in 2019, largely driven by subdued consumption growth as deleveraging gathers pace. We expect this adjustment to be orderly – we are firmly in the 'benign deleveraging' camp. Having said that, the risks are skewed to the downside. With the household savings rate at 1%, we see little buffer for an external shock and domestic credit conditions could tighten further in the wake of a Royal Commission into Financial Services.
For more on macroeconomic trends or a copy of our research report, speak to your Morgan Stanley financial adviser. Plus, more Ideas from Morgan Stanley’s thought leaders.