- Asia's large credit buildup in recent years makes the region vulnerable to interest-rate shock.
- Overstretched borrowers are increasingly exposed should interest rates move higher.
- Debt-fueled price growth makes housing markets in China and Hong Kong susceptible to a correction.
- Excessive bank lending threatens house price growth in Southeast Asia.
A large buildup of credit across Asia in recent years means the region is vulnerable to an interest-rate shock. This shock could come via a tightening in U.S. monetary policy, and could spell trouble for some of the region’s frothy housing markets.
A debt binge
Historically low interest rates and relatively easy credit have buoyed housing demand and price growth across the region, raising the threat of asset bubbles and financial imbalances. Credit has grown rapidly over the past 15 years, reaching close to 200% of GDP in many Asian economies.
Whenever the Federal Reserve begins to unwind its aggressive monetary stimulus of the past few year, this low-interest rate environment could come to an end. Overstretched Asian borrowers have grown vulnerable should interest rates move sharply higher. Repaying debt would become tougher and household balance sheets would suffer. If overleveraged borrowers are left with debts that exceed asset values, the resulting slump in wealth could have disastrous effects on financial systems and wider economies.
The speed at which debt has been accumulated could also lead to a rise in nonperforming loans, bank failures and ultimately a credit crunch. Rising U.S. interest rates are also expected to drive capital outflows from Asia, tightening global liquidity conditions and further weighing on housing demand.
Global credit and housing booms
Excessive credit buildup preceded the housing busts in Japan in the 1980’s and in more recently in the U.S. and Europe. In Japan, the combination of sharp growth in credit and house prices resulted in many bad loans on the books of Japanese banks when overburdened households felt the pinch from rising interest rates. A nearly 70 percentage-point increase in Japan’s credit-to-GDP ratio helped drive house prices up more than 160% from 1980 to 1991 before they crashed. House prices remain more than 70% below their 1991 peak.
Thailand also experienced a double-digit decline in house prices after similar runup in debt before the 1997-1998 financial crisis. Interestingly, Australia's rate of house price and credit growth during the 2000s was similar to Japan's in the 1980s. Yet Australia is among the few developed markets to avoid a sharp housing downturn. A number of factors such as short supply and solid population growth support Australian house prices.
The QE boost
Quantitative easing measures in the U.S., Europe and Japan have exacerbated these trends, as exceptionally low global interest rates have supported a runup in credit growth and house prices across Asia. A flood of cheap money across the Western world has also found its way into housing in Hong Kong, Singapore, Taiwan and Australia, pumping up prices even further. Mainland Chinese buyers, in particular, have helped spur demand and prices in Hong Kong and Taiwan.
If history is a guide, signs of excessive debt-fueled house price growth in China and Hong Kong make these markets the most susceptible to a correction. China’s credit-to-GDP ratio has risen by almost 60 percentage points over the past five years on the back of growing housing demand. Despite tighter monetary restrictions and measures to cool speculation, house prices in Beijing have risen around 20% over the past three years. Households in China are not as burdened with debt as those in the U.S. and Australia, but developers, businesses and local governments have ramped up debt to take advantage of seemingly insatiable housing demand on the mainland. Banks hold about three-quarters of China's debt, and the government is on the hook if these loans go bad.
Hong Kong has seen house prices triple over the past 10 years, making the special administrative region the most expensive housing market in Asia. Rising rates and capital outflows would thus likely hit Hong Kong hardest, as occurred in 2008 when house prices fell 17% in the final six months of that year. Because Hong Kong maintains a currency peg to the U.S. dollar, its interest rates are closely tied to decisions of the Federal Reserve. Rising U.S. rates will thus be instantly transmitted to Hong Kong if the dollar peg stands.
Leveraging and deleveraging
Markets in Southeast Asia also show signs of stress. Bank lending has regularly outpaced GDP growth in most ASEAN economies, and the trend is accelerating in Indonesia, Malaysia and Singapore. For instance, credit is currently growing at more than double the rate of GDP growth in Indonesia and Malaysia, and quadruple the rate in Singapore.
This suggests excess liquidity has flown into asset markets rather than the real economy; house prices have risen between 20% and 30% in Singapore, Indonesia and Malaysia since 2009. Singapore, like Hong Kong, is also susceptible to capital outflows.
Countries that experienced strong growth in credit have also witnessed sharp house price appreciation in recent years. Both trends are likely to reverse as interest rates rise. Deleveraging, which can be seen in falling ratios of bank lending to GDP growth in Australia, Korea, the U.S., and Europe, has tended to coincide with weaker house price growth. Cognizant of this risk, Asian governments and central banks are taking steps to curb excessive debt-fueled housing consumption.
Matthew Circosta is an Economist at Moody's Analytics.
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