Wednesday, September 26, 2007

What do we owe? The nation's entire GDP, that's what.

Australian households now owe almost the nation’s entire GDP in debt. The Deputy Governor of the Reserve Bank presented the figure to a banking and finance conference in Melbourne yesterday and said he expected it to climb further.

Ric Battellino told the conference that as recently as the 1970s Australian household debt amounted to only 20 per cent of annual GDP. He said it climbed to 30 per cent by 1990 and is today approaching 100 per cent.

He said he expected it to climb further because to date the rise in debt had “exhausted neither the collateral nor the debt servicing capacity” of the borrowers.

“Average real income is rising, even after interest payments financial net worth has increased noticeably; gearing levels are not out of line with international standards; and the proportion of households experiencing financial difficulties, though higher than a couple of years ago, remains historically very low,” Mr Battellino said.

In a sign that the Reserve Bank believes that expressions of concern over housing stress are overblown the Deputy Governor said that while there were some pockets of stress “the low numbers involved – less than 20,000 of the 5,300,000 housing loans in Australia are 90 days overdue on repayments – mean that this is not a macroeconomic problem"...

Mr Battellino said the build up of household debt was often wrongly portrayed as being driven by young couples trying to buy their first home.

“A more accurate description is that it is mainly being driven by older, higher-income households that are trading up to higher quality or better located houses, buying investment properties and taking out margin loans to buy shares. These are all signs of rising affluence, driven by a very prolonged economic expansion.”

The Deputy Governor said that debt appeared to be “one of the products, like education and health, which has a high income elasticity of demand – meaning that as income rises, demand for it rises more than proportionately. It would be a mistake, therefore, to conclude that a rising ratio of debt to income is necessarily a sign of financial stress”.

While a debt pile of 100 per cent of Australia’s annual $1 trillion GDP sounded big, as a proportion of the assets of households, the proportion was much smaller, around 17 per cent.

Nine out of every ten dollars borrowed by households in the last ten years had been used to buy assets, mainly houses to live in, houses to rent and shares.

It had happened because “democratisation of finance” which probably had not yet run its course.

“Those of us over 50 years of age can remember when, in order to qualify for a housing loan, people had first to establish a long and consistent record of savings with a bank, and even then there was a tight limit on how much the bank would lend. Many borrowers had to resort to ‘cocktail’ loans, at higher cost, to meet their needs.”

Mr Battellino said central banks could stop the rising trend in household debt “by raising interest rates to levels that exhausted households’ debt servicing capacity” but he did not expect them to.

“Central banks around the world have generally concluded that the level of interest rates necessary to do this is higher than that needed to achieve monetary policy objectives in relation to inflation and economic growth,” the Deputy Governor said.