FNB – Household-Debt Service Risk / Vulnerability declines further

The final quarter of 2014 saw South Africa’s Household Sector continuing to lower its vulnerability to debt-service cost “shocks”.

While still highly indebted and highly at risk, South Africa’s Household Sector continued to gradually lower its vulnerability to any unwanted interest rate hiking surprises or economic shocks in the final quarter of 2014, by further lowering its Debt-to-Disposable Income Ratio. Yet again, though, we emphasize that there is still much work to be done.


The March SARB (South African Reserve Bank) Quarterly Bulletin gave us the 4th Quarter 2014 picture of household sector income and indebtedness.
From this data, we calculate our FNB Household Debt-Service Risk Index, which indicates that the vulnerability of the country’s household sector when it comes to being able to service its debt in future, declined (improved) further in the 4th quarter of last year.

From a revised 3rd Quarter 2014 index level of 5.67 (on a scale of 1 to 10), the 4th quarter saw a further decline to 5.57. This continued a declining trend since the 6.6 revised high recorded in the 3rd quarter of 2012.
However, the level of the Household Sector Debt-Service Risk Index still remains above the key level of 5.4, which indicates that it is still rooted in the “High Risk Range”. However, the Index continues to move in the right direction, i.e down.

This is a positive trend, pointing to reduced Household Sector vulnerability to interest rate or disposable income “shocks”. The most recent index level is also well-below the revised 7.27 peak reached in the 1st quarter of 2006, back in the Household Credit boom just before that start of the previous interest rate hiking cycle. However, to give perspective we must also point out that the level is still far above the low of 2.28 reached late in 1998 just before the start of the consumer boom, so there is still much improvement still needed.

The index is compiled from 3 variables, namely, the debt-to-disposable income ratio of the household sector, the trend in the debt-to-disposable income ratio, and the level of interest rates relative to long term average (5-year average) consumer price inflation.

The higher the debt-to-disposable income ratio, the more vulnerable the household sector becomes to unwanted “shocks” such as interest rate hikes or downward pressure on disposable income. An upward trend in the debt-to disposable income ratio contributes negatively to the overall risk index and vice versa for a downward trend. Then, the nearer prime rate gets to the “structural” inflation rate (using a 5-year average consumer inflation rate as a proxy), i.e. the lower this estimate of real interest rates becomes, the more vulnerable the household sector becomes, the reasoning being that the nearer we may be getting to the bottom of the interest rate cycle and the end of rate cutting relief, the more the risk of the next rate move being upward becomes, or at least the less the chance becomes of further cuts. In addition, households tend to make poorer borrowing and financial decisions on average, while it is tougher for lenders to assess aspirant borrowers, when money is cheap, so better borrowing/lending decisions are arguably made when interest rates are relatively high. Therefore, we view low interest rate periods as ones where risk generally builds up.


Examining the 3 sub-indices of the overall Household Debt-Service Risk Index, the Indebtedness Risk Sub-Index remains the highest at 7.93. However, this source of risk has been declining broadly from a level of 10 as at the 1st quarter of 2008, the quarter in which the Household Debt-To-Disposable Income Ratio reached its all-time high.

Although a weakening economic growth rate over the past 3 years has exerted downward pressure on household disposable income growth, we have seen household credit growth contained to even lower levels, allowing the declining trend in debt-to-disposable income ratio to continue.

According to the SARB’s quarterly household debt and indebtedness measures, Household Sector Credit growth has been contained to a lowly 5.29% year-on-year in the 4th Quarter of 2014, below the 7.05% Nominal Disposable Income growth rate.

The net result was a further decline in the Household Debt-to-Disposable Income Ratio, from a previous quarter’s revised 78.1% to 77.6% in the 4th Quarter of 2014. This brings the cumulative decline in the ratio since the early-2008 peak to 11.2 percentage points, which is significant.

All of this means that the Household Sector is moderately better positioned to weather an interest rate hiking “storm” this time around compared with 2008/9, due to its overall level of indebtedness being considerably lower these days compared to back then.

The declining trend in the Debt-to-Disposable Income ratio also lowers the 2nd Risk sub-index, namely the “Indebtedness Growth Risk Index”, which is now relatively low at a level of 3.0, due to indebtedness being on a declining trend.

The third component of the Household Sector Debt-Service Risk Index is the Interest Rate Risk Index, which remained significant at a level of 5.9 as at the 4th Quarter of 2014, but has been declining of late. The reason for its still- significant contribution to the overall Risk Index is the fact that prime rate remains at moderate levels relative to SA’s long term average inflation rate. This sub-index’s contribution to the overall Debt-Service Risk Index became significant following the sharp decline in interest rates from late- 2008, from 15.5% prime to the 8.5% by the 3rd quarter of 2012.

Those rate cuts moved interest rates to abnormally low levels by SA’s historic standards, given that “structural consumer inflation appears to be somewhere between 5% and 6%. This extreme decline in interest rates from late-2008 was in part due to an abnormal global and domestic economic situation requiring significant monetary policy support.


Further recent gradual decline in the Debt-to-Disposable Income ratio has further reduced the level of vulnerability of South Africa’s Household Sector to interest rate or economic “shocks”. However, the level of vulnerability remains high, and we believe that the level of indebtedness needs to be lowered further.

Our Household Debt-Service Risk Index is an attempt to provide a simple indication of the Household Sector’s level of vulnerability to future economic and interest rate shocks when it comes to ability to service its debt.

Fortunately, the Debt-Service Risk Index has been trending lower, and is now substantially down from its 2006 high, suggesting that if the same magnitude of interest rate hiking as the 2006-2008 hiking cycle were to occur this time around, the Household Sector would weather the “storm” slightly better.

Right now, given the recent positive oil price shock in the form of a major drop in oil prices, along with a decline global food prices, the near term interest rate environment looks benign from a borrower point of view.
However, we reiterate that this positive near term inflation and interest rate environment should rather be seen as a window of opportunity to further lower the Household Sector Debt-to-Disposable Income Ratio, rather than a reason to grow credit at a stronger rate.

While oil price shock risk has perhaps subsided, some key potential “upside risks” to inflation remain, most notably from potential Rand exchange rate shocks. South Africa’s current account deficit on the balance of payments remains huge, and it depends on large levels of net foreign capital inflows to finance the deficit, putting the Rand constantly at high risk of weakness. Any bouts of severe Rand weakness can mean surges in imported price inflation, in turn exerting upward pressure on local consumer price inflation and ultimately on interest rates. Where such pressure on the Rand could intensify is when the US Federal Reserve starts to hike interest rates in that country, an event anticipated by some in the not too distant future.

Therefore, it remains crucial that overall household credit growth remains at pedestrian levels, slower than the Household Disposable Income growth rate, in order to lower the Debt-to-Disposable Income ratio further. In the near term, we expect this positive trend towards a lower debt ratio, and thus lower Household Debt-Service Risk, to continue.