The IMF has issued a warning on Australia’s domestic economy, highlighting the threats to consumption growth from growing household debt levels.
The “Rising Household Debt: What It Means for Growth and Stability” research report says that while an increase in household debt provides a near-term boost to the economy, the positive effects begin to reverse over a three-to-five year time-frame.
Here’s the IMF on their key point:
At first, households take on more debt to buy things like new homes and cars. That gives the economy a short-term boost as automakers and home builders hire more workers. But later, highly indebted households may need to cut back on spending to repay their loans. That’s a drag on growth.
The IMF said developed economies such as Australia are susceptible to a larger negative growth impact from rising debt:
That’s because emerging markets typically have lower household debt, partly stemming from reduced access to credit compared to developed markets.
Running the numbers, the IMF said a 5% increase in the household debt to GDP ratio over a three-year time frame will lead to a 1.25% fall in inflation-adjusted growth three years down the track.
That lag on growth over the medium-term is particularly prevalent for Australia, given that household debt to GDP has continued to rise since since the 2008 global financial crisis.
While it’s a similar scenario for other developed markets such as Canada, the IMF said the household debt to GDP ratio in the UK and US had decreased over that period.
Australia tops its emerging market neighbors in Asia in terms of household debt to GDP. In fact, analysis from HSBC shows that it’s the only country in the region where the ratio tops 100%:
So in that context, the report from the IMF adds another further discussion point to the outlook for domestic consumption — the biggest contributor to quarterly GDP.
While Q2 GDP extended Australia’s uninterrupted run of growth, the numbers showed consumption was propped up by a drop in the household savings rate.
At 4.6%, the household savings rate still has room to fall further but the Q2 result was a nine-year low, and household savings have more than halved from 9.5% at the start of 2013.
In that context, the figures in the IMF report suggest domestic consumption could still be facing some headwinds in upcoming quarters as households look to pay down debt.
The IMF research can also be considered in conjunction with high energy costs and the fact that the red-hot Sydney and Melbourne housing markets are showing consistent signs of cooling.
Not surprisingly, the IMF also concluded that highly indebted economies are more susceptible to a financial crisis from an unexpected macroeconomic shock. However, the research also showed that a country such as Australia is also quite well placed to reduce debt risk.
“Countries with less external debt and floating exchange rates, and which are financially more developed, are better placed to weather the consequences,” the IMF said — all boxes Australia’s economy ticks.
In addition, the IMF said macro-prudential tools can be useful. In a research report earlier this year, Morgan Stanley analysts said Australia’s mortgage market is particularly well-suited to macro-pru, given the broad powers of banking regulator APRA to issue regulatory measures across all banking jurisdictions.
Despite that, Australia’s high debt levels will continue to be a key factor in the outlook for domestic consumption.
For now, high house prices and mortgage costs are seen as one of the main reasons why the Reserve Bank is in no rush to raise benchmark interest rates from their current level of 1.5%.
The IMF based their report on a sample of 80 countries where household debt levels have risen since 2008, across both developed and emerging markets.