The risk of an Australian debt crisis 'isn’t as big as it first appears'


As a nation, Australia carries a lot of debt. As a percentage of GDP, private non-financial sector debt currently stands at 205% of GDP according to data released by the Bank of International Settlements (BIS), a level akin to that of China, a nation who many fear is on the precipice of a debt crisis.

Australia’s debt loading, along with its close ties to China, has seen some speculate that a debt crisis down under could also be on the cards.

Indeed, only recently Australia was deemed to be the world’s second most vulnerable country to a debt crisis and recession hitting in the next one to three years according to an article in Forbes, beaten out of the unenviable top spot by China.

The article suggested a country was at risk of a debt crisis and recession if the level of debt held by the non-financial private sector was greater than 175% of GDP, and if that debt-to-GDP ratio had risen more than 10 percentage points (ppts) over the last year.

Based on the analysis, and the fact Australia’s debt loading grew by 13ppts last year, it indicates, based on these metrics at least, that the risk of a debt crisis is growing.

Source: Capital Economics

To Paul Dales, chief Australia and New Zealand economist at Capital Economics, while there are concerns, particularly towards the household sector, recent data suggest that risks of a debt crisis may be receding, rather than rising, at present.

“The household sector poses the real risk, with the debt to GDP ratio rising from 110% in 2012 to a record high of 125% now. And since 70% of that is made up of housing debt, it all boils down to whether or not you believe that the rise in housing debt is built on shaky foundations,” says Dales.

Though he admits “there’s a risk that at some point a major fall in house prices and/or a rise in interest rates will mean that some of the debt won’t be repaid”, he suggests there are a few factors that suggest the risks are building

Here’s a snippet from a research note released on Friday explaining why.

To start with, Australia’s household debt to GDP ratio looks higher than it really is as it doesn’t take into account the cash that households have in offset accounts. Many borrowers have taken advantage of the fall in their mortgage payments triggered by low interest rates to raise their savings in offset accounts.

This effectively means they are paying down their mortgage faster than required. The RBA estimates that if these funds are subtracted from total debt, then the housing debt to disposable income ratio (and hence the debt to GDP ratio) is more or less where it was during the GFC.

The chart below, supplied by Capital Economics, reveals Australia’s housing debt level as a percentage of disposable income — both with and without the inclusion of offset accounts — according to figures released by the Reserve Bank of Australia (RBA).

Alongside many households being well ahead on their mortgage repayments, Dawes suggests that tighter lending standards and a recent reduction in interest only home loans believes “that the risk (of a debt crisis) isn’t as big as it first appears”.

While Dawes says that he can’t completely rule out a debt crisis eventuating, he suggests the “problem probably won’t emerge until the RBA starts to raise rates from record lows, which may not happen for a year or two yet”.

“The latest evidence suggests that by then, the foundations of the mortgage market may be looking a bit more solid.”

Given the alternative scenario, let’s hope he’s right.

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