Debt soars as households keep economy afloat

The National Bank's economist warns interest rates may soon show their teeth, writes BRIAN FALLOW.

WELLINGTON - Households have increased their bank debt by $5.2 billion or 9.6 per cent over the past year, according to Reserve Bank figures.

But the National Bank says a repeat of the debt-propelled boom of the mid-1990s is not on the cards.

"The household sector is doing a mighty job keeping the economy afloat, buoyed by low interest rates," said the chief economist Brendan O'Donovan. "But there's only so long this can continue."

Progressive rises in interest rates, starting early next year, would bite into household spending as debt servicing costs increase.

Though interest rates are more stable than in the past, and unlikely to rise to the heights they did during the last cycle, any resulting tendency to take on more debt would be offset by the fact that inflation could no longer be relied on to erode the principal, Mr O'Donovan said.

House prices, the key driver of household wealth, were likely to be constrained by the fact that net migration was likely to remain outward for some time yet, the ratio of house prices to disposable income remained at historically high levels, fixed mortgage rates had already started to rise and floating rates were likely to start rising in March next year.

In the past the "wealth effect", in which people increase their consumption on the strength of increases in their real wealth, has been unusually strong in New Zealand. That reflected the fact that a very high proportion of New Zealand households' wealth is tied up in real estate rather than financial assets, Mr O'Donovan said.

After growing strongly through the mid-1990s, fuelled by rising house prices, household wealth declined in 1998, for the first time sine 1991. But that was not matched by a slowdown in consumer spending, Mr O'Donovan said, contrary to the bank's modelling which indicates a strong link between wealth and spending.

The explanation appears to lie in the historically low interest rates which have prevailed since the last quarter of 1998, which have reduced debt servicing costs.

But the stock of debt to be serviced has ballooned over the 1990s. Household liabilities have grown 140 per cent since 1989, while household assets remain heavily concentrated in bricks and mortar. The share of assets in housing has been declining, from 72 per cent 10 years ago to 67 per cent now.

One of the things which made the 1990s surge in household indebtedness possible was that it was coming off a relatively low base, in relation to incomes, by international standards.

But New Zealand had now caught up with international norms in terms of the debt-to-income ratio and overtaken the field in terms of debt-to-assets, Mr O'Donovan said.

As a result households' capacity to increase debt was now more limited than in the past. That would act as a constraining influence on the growth in household spending over the next few years.