Household debt: between a rock and a hard place

Australian over-indebtedness leaves households poorly positioned for future movements in the target cash rate.

Over-indebtedness is a cause for concern. Make no mistake, debt itself is okay if serviced appropriately. It can facilitate a higher standard of living and stimulate growth opportunities which simply aren’t available when drawing solely upon equity. Over-indebtedness, however, is defined as a level of debt taken on where owned assets do not cover 75% of the debt’s value; a position that would leave households vulnerable to economic shocks.

According to the ABS’s 2018 figures, 29% of Australian households were classified as over-indebted; a significant rise from 21% back in 2004. Moreover, the average household debt has increased 79% in real terms in the previous 12 years, compared to a 38% increase in average income and 51% in asset value. 

Ominously, a significant chunk of this debt is attributable to mortgages. More than half of total Australian household debt is caused by mortgages (56.3%), with oft-cited credit debt and student debt only constituting 1.9% and 2.1% of total debt respectively. This gross over-reliance on an illiquid asset with high price volatility is a recipe for disaster. 62% of households with property debt owing to someone aged 25-34 years old were classified as over-indebted, with that metric being 51% for 35-44 year-olds. Young people, in particular, are taking on mortgages which present them with tremendous financial vulnerability. 

This gloomy outlook is compounded by sluggish income growth and a startling depression in purchases from disposable income. Macks Advisory claims that such purchases have been running at less than half their usual level (2.75%, down from an average of 6%). On top of this, the average household savings rate in Australia sits at a paper-thin 1% of disposable income. 

Australians are scarcely saving, yet they are reducing their spending. At the same time, households are assuming unsustainable debt positions fuelled by a historically low target cash-rate (1.0% at the time of writing). 

This puts the economy firmly between a rock and a hard place. Classical economic theory would posit that depressed consumer confidence and spending should be met with a reduction in the target cash-rate. 

The problem? 

A reduced target cash-rate to below 1% would further fuel the issue of cheap debt and facilitate over-reliance on repayments – repayments which would necessarily detract from the future ability to use the disposable income for discretionary spending and saving. 

On the other hand, increasing the target cash-rate to deter households from taking on untenable debt positions would be a colossus failure. The ABS estimates that a 1% rise in mortgage interest rates would result in additional interest payments equal to roughly half of the households’ existent principal repayments. For households already struggling to meet repayments, failing to save disposable income, and reducing their discretionary spending, it is difficult to assess where this extra money would come from. When we consider the fact that less than a third of Australians expect to reduce their debt this year due to them being ‘unable to’, it is unviable to increase the cash rate (Australian Financial Review, 2019). 

To top off this depressing assessment of the Australian climate, Morgan Stanley recently conducted a global research report into the vulnerability of various economies’ household debt positions. The bank concluded that Australia was at the highest amount of risk from cutting back on household debt in the world

Once again, it seems that the Australian economic outlook is going to be relying upon fiscal policy to navigate its way out of a precarious position. Whether the Australian Government has the structural capacity or economic nuance to respond to the quickly-changing landscape effectively is unclear. 

If any cause for optimism exists, it is that the current Government deficit as a share of GDP is at a manageable level. In turn, this could enable further borrowing in the wake of an economic slowdown. It is up to the Government to loosen the purse strings and stimulate an economy whose households are stuck between a rock and a hard place. 

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