The risk posed by high Malaysian household debt

Malaysia is presently facing a challenge that is greater than during the two years beginning from June 1997 when both the ringgit and Kuala Lumpur Stock Exchange (now Bursa Malaysia) went plummeting. The country survived those years, now referred to as the Asian Financial crisis, with some help from the strong global demand for Malaysian primary commodities (except petroleum) and the increased exports in manufactured (especially electrical and electronic) goods. These strengthened our trade balance. Though Malaysian officials have credited the pegging of the ringgit as key to Malaysia’s recovery, this is not entirely clear. Other countries such as South Korea and Thailand that were hit with greater force by the crisis did manage to recover without similar controls. Significantly, though, the performance of the South Korean economy since then has been exemplary.

One of the reasons the Malaysian economy was not hit as hard as our neighbours during the 1997 crisis was due to our private debt structure. Malaysian companies had less foreign currency denominated debt, and as such the loan repayments had little currency risk. Household debt too was low, and people by and large were okay after 1999. While some say that the risk posed by local corporate debt is manageable during the present crisis, household debt ought to be a cause for great concern.

Figure 1: Household financial assets and debt (RM)

Source: Bank Negara Malaysia

Figure 1 above presents the growth of household financial assets and debt. Household financial assets consist of currency deposits and the market value of unit trust funds and equity holdings. Both households’ financial assets and debt have been growing steadily between 2005 and 2014, a compound annual growth rate (CAGR) of 10.0% and 11.2% respectively. However, households have been accumulating debt at a faster rate than they have been accumulating financial assets as the household debt to household financial asset ratio rose from 42% to 47% during this period. This is mainly due to Malaysian banks consciously diversifying their loan portfolios after the financial crisis to reduce their exposure to corporate debt. It is widely accepted among financial experts that a diversification of assets reduces risks. In this case, the banks increased their share of loans to household to reduce the overall risk of their loans.

Figure 2: Household financial assets and debt as a percentage of GDP

Source: Bank Negara Malaysia

When we compare these figures with the Gross Domestic Product (GDP), the effects are clearer to see. Figure 2 above displays the ratio of both household financial assets and debt to GDP for the period from 2005 to 2014. Household financial assets as a percentage of GDP fell by 23% between 2005 and 2014 while household debt as a percentage of GDP rose by 19% during the same period. As a result of the latter, Malaysia has one the highest household debt to GDP ratio in the region.

Household debt is mainly composed of loans for properties (which make up more than half the debt) and motor vehicles. Although the government had taken steps to discourage speculative investment in properties, the prices of residential properties are high in Malaysia considering the relatively low wages workers earn. Malaysia has been the most liberal country in the region in allowing foreigners to own residential properties. While the rules may differ among states, the previous minimum of RM500, 000 was raised to RM1 million by the government in 2014. Neither minimum limit is a significant barrier to our wealthier neighbours. The net effect of this is that it drives the prices of residential properties up significantly to the extent that young families are facing great difficulty in purchasing residential units in the major metropolitan areas. The cost of home rental has also gone up. Wage earners have had to take large loans to finance their purchases. Likewise, due to the high tax regime, motor vehicles have been expensive to buy in Malaysia. However, we Malaysian still continue to subsidise wealthier foreigners under the Malaysia: My Second Home Program who get to own a car tax-free. This works out to a discount of about 40% of the price we pay for a new car. It is also unlikely that duties on motor vehicles will be reduced anytime soon, especially with the government desperate for cash despite becoming a party to the Trans-Pacific Partnership Agreement (TPPA).

Households need to manage their finances with discipline. The Goods and Services Tax (GST) followed by the dismal ringgit, and now the weakening economy are cause for great concern especially for the lower income households who are the ones going to suffer the most. Firstly, we must note that financial assets are not distributed proportionally across households. The debt to financial asset ratio of lower income households will be higher than that of high income households; for many it will be above 100%. Lower income households spend a greater proportion of their income on food and other expenditures, and as a result would have a lower savings rate. Instead, the easing of credit to poor households would possibly have resulted in many of them spending a significant amount of income on debt servicing.

With the implementation of the GST, the cost of living has risen significantly.  The low ringgit also causes inflation, and this is not just for goods but also for the cost of borrowing for households and businesses alike. If the inflation rate rises, as it will when the ringgit depreciates vis-à-vis our trading partners, investors with cash would expect a higher return from bonds. This will push interest rates higher, thereby increasing both borrowing costs and monthly repayment amounts for loans.  As most loans in Malaysia have variable interest rates, many households, who are already strained by the higher living costs, will find it more difficult to service their now larger loan repayments. As there is a positive relationship between how much debt a household carries and loan delinquencies, the proportion of household loan defaulter is likely to rise. With a greater proportion, and a greater number, of households carrying debt now than in 1997, this could only increase the number of potential defaulters.

The domestic demand for goods and services is bound to weaken as real income falls. Since the global economy is also weakening, the demand for exports too will not be very strong in spite of a cheaper ringgit. The government’s expenditure would be unable to grow to compensate for the decrease in investment, consumption and exports. We therefore cannot expect a high growth scenario for Malaysia in 2016. Jobs in certain sectors will not grow or maybe at risk; forget real wage increases. There would of course be opportunities for good deals out there, but for most Malaysians the advice would be to be very careful with the purse. This scenario also suggests that wealth and income inequality will further rise in the country.