The vicious cycle of high household debt

This article was first published in the forum, The Edge Malaysia Weekly, from March 25, 2024 to March 31, 2024.

The reason for the need for reform in Malaysia’s highly subsidized economy is the stubbornly high level of household debt.

One of the reasons for the increase in household debt is the long-term low interest rate environment. If monthly repayments are well managed thanks to low interest rates, households will not be encouraged to reduce their debt.

Malaysia’s household debt as a percentage of the economy has generally exceeded 80% since 2012. According to Bank Negara Malaysia’s latest report, household debt as a percentage of gross domestic product (GDP) was 84.2% as of December last year, a slight increase from 81%. One year ago it was %.

Over the past 15 years or so, that number has gradually increased. In 2009 and 2010, household debt as a percentage of GDP was 76%. It finally reached the 80% level in 2012 when Datuk Seri Najib Razak was prime minister. It must be noted that the rise in household debt is not the fault of Mr Najib, who is currently in jail for convictions related to 1Malaysia Development Bhd.

Rather, it is a result of the global monetary easing policies that arose as a result of the US liquidity and financial crisis.

The United States, the world’s largest economy and largest capital market, embarked on a near-zero interest rate regime in 2009/2010 to save its banking system and economy. That was the beginning of the global low interest rate environment.

In many ways, it benefited Malaysians as a whole.

Before the US Federal Reserve embarked on accommodative monetary policy, Bank Negara’s overnight policy rate (OPR) hovered between 3% and 3.5%. When the US lowered interest rates, central banks followed suit. In the past, when the US and other developing countries kept borrowing rates near 0%, Malaysia’s operating margin was 1.75%.

For Malaysians, the OPR of 1.75% was a generous number. This has significantly increased the affordability level of homes and cars. Those with an income of RM5,000 or more can easily pay their home loan payments or monthly rental purchase installments.

However, the Fed began aggressively raising interest rates in March 2022, and interest rates have gone from nearly 0% to now between 5.25% and 5.5%, the highest level in 23 years. The rate hikes within 18 months were aimed at curbing inflation, which reached a 40-year high in early 2022.

Bank Negara’s operating profit margin also increased little by little, but there was no need to do so aggressively in line with the Fed’s interest rate hikes. The reason is simple.

Firstly, Malaysia’s inflation rate is quite subdued due to the heavily subsidized economy. Subsidies are provided for water, electricity, gasoline, and essential items. This keeps inflation levels in check, unlike other countries where food prices soar through the roof.

Second, Malaysian businesses and households cannot afford to manage their lives in a high interest rate environment. Even if his operating profit margin is 3%, the actual lending interest rate charged by the bank will be well twice that of a borrower with a higher credit rating.

Riskier borrowers end up having to operate with higher interest costs of 8% or more per annum.

One of the consequences of keeping interest rates relatively low compared to developed countries such as the United States is the depreciation of the ringgit.

The weak ringgit has become a political issue. However, in reality, a strong ringgit that is not accompanied by fundamental or structural reforms will eat into the real economy and hit people’s pockets hard.

The country’s high household debt is part of a vicious cycle.

A low interest rate environment does not provide incentives for households to instill financial discipline. With the inflation rate low, Bank Negara has no reason to raise operating margins that would lead to a stronger ringgit.

Inflation is kept low thanks to blanket subsidies. And governments cannot simply abolish block subsidies without putting in place systems to ensure that the poor are not affected and general income levels rise.

Bank Negara Governor Datuk Sheikh Abdul Rashid Ghafoor said during the release of the central bank’s annual report last week that Malaysia has an opportunity to undertake structural reforms.

Prime Minister Datuk Seri Anwar Ibrahim is right as he came to power without any baggage. Unlike previous prime ministers who came to the position after many years in government, Mr. Anwar has been outside the government since 1998. It also holds a two-thirds majority in parliament.

On paper, he should be able to implement structural reforms.

The Anwar administration is considering abolishing comprehensive subsidies. The ultimate goal is to get more funding directly into the hands of people who need it. The task was given to Economy Minister Rafizi Ramli.

Apart from subsidies, the government also aims to reduce spending and improve foreign direct investment (FDI). In that regard, Mr. Anwar has a track record of attracting investors. The question is when will FDI start flowing in?

Furthermore, domestic investors should be encouraged to put their money within the country rather than looking for opportunities abroad. To do so, Malaysians, especially non-Malays, must have confidence that there will always be a place for them here.

Talk of a boycott and strong statements by leaders such as Umno youth president Dr Muhammad Akmal Saleh have not helped to assuage non-Malay sentiments. Some people think this country is a place to make a living, not a place to make long-term investments.

FDI and domestic investment are essential to sustain economic growth, create jobs, and improve the overall welfare of the population. These lead to the creation of resilient economic models without the need for blanket subsidies.

Coupled with disciplined handling of public funds, this will ultimately lead to an improvement in the household debt-to-GDP ratio and a stronger ringgit.


M Shanmugam is a contributing editor at The Edge

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