Cheap debt helped households ride out the economic disruption of the pandemic but left a large overhang that is becoming costlier as interest rates rise, says Moody’s Investors Service in a new report.
The rating agency reported that, as of the second quarter, global household debt was US$8 trillion higher than its pre-pandemic level, at about US$57 trillion.
“Household borrowing during the pandemic moderated the effects of the economic downturn, but it has led to a large debt legacy,” it noted.
That said, many households are now in better shape financially than they were before the pandemic, as they refinanced mortgages and paid down high-interest credit card debt during the low-rate conditions, Moody’s added.
Indeed, despite the rise in debt, the report said that household defaults aren’t expected to rise given strong labour markets and household savings.
However, the report indicated that higher interest rates “are a drag on real consumer spending” as households have to spend a bigger share of their disposable income on servicing debt.
This drag is exacerbated by inflation, which also weighs on consumer spending.
Lower-income households are more affected by these trends, it noted.
“As growth slows, an uptick in unemployment rates would financially stress more vulnerable households, particularly those with low income and limited financial buffers,” it said.
At the same time, households that have used their growing debts to finance real estate investment are increasingly exposed to declining home prices.
“Risks are higher in countries including Australia, Canada and Korea, as well as China, Thailand and Vietnam, where housing valuations are more stretched, household debt levels are elevated, and a larger share of household debt has variable interest rates,” Moody’s said.
While declining house prices can improve affordability and reduce inequality, “households with a larger share of wealth locked up in residential property are more sensitive to housing price movements,” the report said. “They are more likely to cut back on consumption in the event of income and wealth shocks.”
The report said that risks to overall financial stability are mitigated by tougher capital rules and other banking sector reforms that were adopted in the wake of the financial crisis.