As Canada’s economy begins to slow, the country’s growing household debt burden is raising new concerns as it outpaces that of most developed countries.
In fact, Canada had the second-biggest jump in household debt-to-income ratios of any country other than Greece between 2007 and the second quarter of 2014, a new study says.
Canada and Australia along with a number of countries in northern Europe “now have larger household debt burdens than existed in the U.S. or the U.K. at the peak of the credit bubble,” according to a new analysis.
The McKinsey Global Institute looked at 47 countries and identified seven with “potential vulnerabilities” in household debt that could lead to financial instability and a consumer spending slowdown: the Netherlands, South Korea, Sweden, Australia, Malaysia, Thailand – and Canada.
The study, to be released Thursday, comes amid mounting evidence of a sputtering economy. The country’s GDP shrank in November, and last year’s job growth has been revised lower while oil prices have slumped, restraining business development.
The report was based on data to the second quarter of last year.
Since then, several factors make the picture in Canada more stark: Household debt-to-income ratio rose further, to a record 162.6 per cent in the third quarter. House prices continued to climb, though the pace is slowing. And the Bank of Canada cut interest rates last month – with another reduction possible in March – moves that could spur even more borrowing.
“What the financial crisis showed us is that when you have rising real-estate prices and rising household debt, it can be a deadly mix. You have to manage each carefully,” Susan Lund, Washington-based McKinsey partner, saud in an interview.
It is crucial to monitor household debt levels closely, she said – in particular, which segments by income or demographic group seem to be slipping under water. And policy makers need to tighten lending standards and reduce mortgage size limits when markets are overheated.
Of the central bank’s rate cut, Ms. Lund said it’s “tempting to try to spur growth through credit. But it makes the need to monitor debt more urgent.”
If left unchecked, the risk is that households will no longer be able to afford the debt they’ve taken on. They could either be vulnerable to foreclosures and bankruptcies – or they could slash spending to pay back debt. That in turn could reduce consumption, which could dent economic growth and trigger a recession – a “downward spiral,” according to Ms. Lund.
The study looked at whether high household debt in some countries will eventually spark a crisis. It analyzed the level and growth of debt-to-income ratios, debt-service ratios, and house price changes. By these metrics, it highlighted Canada as being one of the most at risk.
The Bank of Canada has long held that rising household debt poses one of the biggest risks to the domestic economy – though it has also become increasingly focused on lower oil prices.
Residential mortgage credit grew by 5.3 per cent in Canada last year while non-mortgage credit growth expanded by 3 per cent amid more personal lines of credit, Royal Bank of Canada noted Wednesday. The pace of growth for both kinds of credit accelerated in 2014 from a year earlier.
House prices have been a key factor in debt growth. Between 2000 and 2007, house prices zoomed higher in many countries – by 138 per cent in Spain, 89 per cent in Canada and 55 per cent in the United States.
Rising house prices have led to larger loans. With more banks willing to lend, real estate prices have climbed higher still. “The correlation between growth in real estate prices and household debt is seen across countries,” the study said.
The seven countries with household debt that “may be unsustainable” have both the highest debt-to-income ratios and significant growth since 2007. Canada is the exception in having better debt-service ratios, though that could change when borrowing costs rise. In all, “these figures suggest potential risk but do not signal imminent crises.”
There is a caveat – Canada’s household debt numbers include the debt of unincorporated businesses, which is counted as corporate debt in other countries. That may inflate Canada’s numbers, though McKinsey notes that the trend lines still show continuous growth.
The Globe and Mail
Published Thursday, Feb. 05 2015, 12:01 AM EST
Last updated Thursday, Feb. 05 2015, 6:19 AM EST