Debt levels remain too high despite rate cutting
July 27, 2009
By Ethel Hazelhurst
As interest rates fall, households are finding it easier to meet their interest bills. But FNB property strategist John Loos identifies a potential time bomb in the economy - household debt levels remain too high.
The interest bill, as a ratio of disposable income, fell to 14.4 percent in the first quarter, from 14.8 percent a year earlier, but only because of the Reserve Bank's aggressive rate cuts, Loos says.
The problem is there is little scope to cut rates further. At best, there may be a half or one percentage point cut later this year, which would bring benchmark mortgage rates down to 10.5 percent or 10 percent. Then, at some point, the rate rising cycle will kick in. Loos says it looks increasingly likely that household debt will still be too high at that point.
Essentially the problem is that disposable household income - income after tax - is falling. Loos says in the first quarter it fell 4.5 percent, compared with the previous quarter. The figure has been annualised, in other words, multiplied by four.
News of the fall comes as a surprise, in the light of recent double-digit wage increases. Nedbank group economist Dennis Dykes explains the apparent anomaly.
One reason is that, while wages are rising, job numbers are falling as companies retrench to cut costs. Another reason is that about 20 percent of total income comes from investments, which includes dividends from shares and interest rates from savings, according to Dykes.
Now things become clearer. The 4.5 percentage point cut in interest rates since December has benefited debtors but penalised savers. And, with economic activity weak, companies are not performing well, so dividend payments are much lower than they were previously.
Dykes estimates that income from these sources is likely to fall by 4 percent this year, while employment will fall by about 2 percent.
Of course, the picture is worse when income is adjusted for inflation. And it looks as if inflation will continue to erode incomes in the forseeable future. When an economy is caught in an inflationary spiral, price hikes follow wage rises like night follows day.
The exception to that rule occurs only when local producers are faced with stiff competition, both at home and from abroad. But that's another chapter in an equally complicated story.
Comments from Jean Francois Mercier, an economist at Citi, also reflect caution about the immediate future.
He says: "Indications of an upturn in the local economy remain less convincing than in most industrial and many emerging countries. At the same time, the past few months have consistently delivered higher consumer price inflation than the consensus expected, suggesting that inflation stickiness leaves South Africa among the 'higher inflation' group of emerging countries in the current year."
The solution isn't simple. The problem with countercyclical policy is that cycles don't always glide smoothly from one phase to the next. Flaws in economic fundamentals can distort the transition.
This became apparent in the 1970s when stimulatory policies didn't stimulate and measures to curb inflation failed. The result was low growth and high inflation - stagflation. There are signs this stagflationary situation may recur globally, given zero interest rates in major economies and huge doses of liquidity administered to the global economy.
Attempts to normalise the situation by withdrawing the liquidity could abort a recovery and leave a long inflationary tail.
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