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An analysis by investment bank Morgan Stanley of the world’s 10 leading developed economies has concluded that Australia’s economy is most at risk from household debt reduction due to weakening house prices and the possible introduction of further macro-prudential or tax changes.
While acknowledging that the Australian economy has been resilient, with GDP growth north of 3 per cent and unemployment down to 5 per cent, the US investment bank believes that this is unlikely to continue, noting that the nation’s predicament is compounded by the need for debt reduction at a time when the household savings rate is just 1 per cent of disposable income.
“Risks are building, given the consumer has supported consumption by tapping into their savings rate, which has fallen to 1 per cent, while the residential construction cycle is peaking now, and will exert a drag on currently record high construction employment,” Morgan Stanley warned in its 68-page report.
“Credit remains tight and an ongoing overbuild is driving weakness in the outlook.”
Based on the investment bank’s Household Deleveraging Risk Indicator — which makes an assessment of the economic outlook of each G10 nation based on levels of household debt, structural factors in the economy, and the likelihood that near-term deleveraging will be necessary — reduced levels of debt in the US, Japan, the European Union and the UK have been offset by increased debt volumes in Australia, followed by Sweden and Canada, then Norway.
“Strength in the global economy and support from public infrastructure spend are mitigating these headwinds, but the risk of a longer/deeper-than-usual balance sheet recession remains elevated, if these conditions change,” Morgan Stanley stated in its report.
It expects Australia’s economy to enter a “benign deleverage phase” as the housing market continues on its downward slide in the coming years, due to high debt-to-income, debt-to-asset and debt servicing ratios.
“Leverage and debt service is high and the second most externally funded, while falling house prices and slowing credit growth suggest more imminent risks of deleveraging,” the Morgan Stanley report stated.
“Most concerning about the potential impact of a deleveraging phase for Australian households is the narrow savings buffer that is currently carried.
“From the perspective of wealth effects, our forecast 10 to 15 per cent real house price decline would combine with 20 per cent debt/asset gearing levels to inflict a serious dent in net worth.”
As such, Morgan Stanley estimates that Australian households could face a collective $700 billion cut to their wealth, which could in turn drag consumption down by 1 per cent to 4 per cent in the next two or so years.
As the economies of Australia, Canada, New Zealand and the Scandinavian nations in the G10 have continued to borrow heavily, Morgan Stanley noted that central banks have been focusing on financial stability using macro-prudential measures, such as caps on investor and interest-only loan growth in Australia and limits on loan-to-value ratios in New Zealand.
The Reserve Bank of Australia’s focus on financial stability, according to the investment bank, means that increases in the official cash rate (which has been on hold for more than two years) will be gradual, and while a hike to the rate could push up the Australian dollar, the impact will likely dwindle.
The Australian dollar is the weakest for leverage, according to Morgan Stanley’s analysis, and is expected to continue to slide in the coming years.
There are also uncertainties around potential limits on negative gearing to new housing and the halving of the capital gains tax concession, as proposed by the Labor Party should they win the next federal election, which could exacerbate economic challenges, the investment bank noted.
[Related: APRA tells RC there is ‘a role’ for expense benchmarks]
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