Wednesday, October 4, 2017

IMF warns on rising household debt and risks of "debt overhang"

Australia's high levels of household debt leave it potentially exposed to a global economic shock or a banking crisis, the International Monetary Fund has warned.

An IMF study into highly leveraged households and financial stability singles out Australia where household debt has risen to 100 percent of GDP, well ahead of other advanced economies where the ratio is lower at 63 percent.

"Higher growth in household debt is associated with a greater probability of banking crises," according to the IMF's latest Global Financial Stability Report.

"New empirical studies - as well as recent experience from the global financial crisis - have shown that increases in private sector credit, including household debt, may raise the likelihood of a financial crisis and could lead to lower growth."

The IMF warns the level of household debt "remains high by historical standards" and "has kept growing in other advanced economies such as Australia and Canada".

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While report says that debt can be positive in the long term, it cites research showing that high household indebtedness can cause "a significant debt overhang when a country faces extreme negative shocks".

"The global financial crisis suggests that high household debt can be a source of financial vulnerability and lead to prolonged recessions".

In addition to Australia and Canada, the study says Cyprus, Denmark, Switzerland and the Netherlands are also exposed to significantly higher levels of household debt.

The Reserve Bank of Australia has repeatedly warned about rising levels of household debt and that slowing wages growth means some consumers could struggle to meet mortgage repayments when interest rates start rising.

"Growth in housing debt has been outpacing the slow growth in household incomes for some time," governor Dr Philip Lowe said in a statement.

While the IMF points to positive effects of higher debt of through higher growth and lower unemployment, it warns the benefits are typically reversed in three to five years.

"There is a trade-off between the short-term benefits of rising household debt to growth and its medium-term costs to macroeconomic and financial stability," the study says.

The IMF also warned that some households increase debt and consumption based on the perceived wealth of their real estate investments.

"Households that base their expectations solely on extrapolations from past events, when house prices have been growing, may increase their borrowing during housing booms because they expect their home equity to continue growing," the research says.

Globally, the median household debt-to-GDP ratio among emerging market economies increased from 15 percent in 2008 to 21 percent in 2016.

Among advanced economies, the ratio increased from 52 percent to 63 percent over the same period.

The IMF says the negative medium-term consequences of higher household debt are more pronounced for advanced economies than for emerging market economies, where household debt is lower.

However, the IMF suggests that fallout from high household indebtedness could be softened if countries improve their financial regulation, reduce dependence on external financing, adopt flexible exchange rates, and lower income inequality.

The IMF's study is based on a study of more than 80 advanced and emerging economies where debt levels are rising a decade after the global financial crisis.

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