We believe that global credit risks are much less systemic than a decade ago, especially in larger advanced markets, although pockets of vulnerabilities do exist, particularly in high-yield corporate debt and US commercial property. And there has been a major rotation of global credit risks – above-trend credit growth has been a feature of emerging markets in recent years, a mirror of 2007, when credit growth had grown furiously in several key advanced markets.
Over the past decade, households have deleveraged in those countries that suffered a financial crisis. But ultra-accommodative monetary policy has contributed to household debt increasing globally.
The report states that rising household credit only starts to hurt growth and financial stability after the debt stocks reach a certain threshold: 30% of GDP in the case of long-term growth and 65% of GDP for financial stability.
The report’s findings are potentially worrying for countries currently experiencing high household debt growth and feature a stock above the thresholds. High household debt affects GDP because of the damage to aggregate demand caused by prolonged deleveraging, and is estimated to be quite considerable, with a five percentage points increase in household debt-over-GDP ratio hurting growth by 1.25 percentage points. The report finds that even for those countries where debt is not growing, a high stock of debt can have some negative impact on long-term income per capita growth.
In most countries exhibiting the fastest growth, the stock is above the threshold at which financial stability risks begin to increase. While the probability of a fully fledged banking crisis in this scenario is, at a given year, still low, it is considerably higher than in the unconditional probability of a banking crisis.
Ten countries in our sample feature the problematic combination of growing debt stock and level of debt above both thresholds. We single out the five where household debt is growing the fastest as those that require closer scrutiny: Australia, Korea, Norway, Switzerland and Canada. In these countries, debt as a share of GDP has grown at a similar or higher growth than in the preceding years of the prototypical financial crisis.
The threshold approach summarises decades of experience across economies but there is no substitute for country-specific analysis of how individual economies and their institutions are able to cope with high levels and growth rates of debt. The IMF report finds that there are mitigants to general conclusions. For example, flexible exchange rates, quality of supervision, and transparency of consumer protection regulations and policy can potentially mitigate the risks.
The IMF is right to highlight risks associated with trends in household debt. Mounting household balance sheet vulnerabilities do represent meaningful and increasing downside risks in a scenario of higher interest rates. Eventually, long spells of increasing debt in some countries are likely to mean that lenders start tapping into subprime borrowers with low capacity to repay, which over time may create generalised distress even under stable interest rates.
But we believe the risks could be overstated: there are two key respects in which the current environment is less risky than the 25-year history on which the report relies. First, we expect to be in a low rate environment for many years to come, strengthening debt-servicing capacity for longer than usual. Second, we think monetary and regulatory policy regimes have improved overall, particularly in EM, which we think have passed the mother of all stress tests in the 2015-16 period of capital outflows.
The IMF report offers a timely reminder that macroprudential tools are effective in reining in household debt growth. Policymakers will need to start acting decisively now.
Guillermo Tolosa is an economic advisor at Oxford Economics