Household stress emerging

THE EDGE WEEKLY ISSUE#1001

THE WEEK OF FEBRUARY 10 – 16, 2014

THE STATE OF THE NATION

A WEEKLY UPDATE

Are Malaysian households beginning to feel the pinch?

Last week, we published a special report entitled “The State of the Nation”.  It addressed various issues about the economy, the stock market and politics today that you need to know.

Using the horse as an analogy, given that this is the year of the Wooden Horse in the lunar calendar, The Edge argued that for Malaysia, it is not a wooden, but WOUNDED horse.

The horse was overstretched in the last few years, galloping after being fed financial steroids.  The fiscal indiscipline and consumption spree of the last few years were facilitated by a massive injection of cheap global liquidity and an enormous growth in domestic bank loans to consumers.

The steroids are now being gradually withdrawn.  Liquidity is moving out of emerging markets and interest rates are set to rise globally.  Chart 1 shows the performance of major world stock markets since the start of the Year of the Horse.  Clearly, the horse is not galloping.  Whether this is due to poorer-than-expected manufacturing data from the US and China or the strengthening of the yen is secondary.  The point is that the world is in a period of uncertainty.

The stock markets did not only fall over the last few trading days, but more significantly, they all saw single-day plunges.

Japan’s Nikkei 225 and Hong Kong’s Hang Seng Index plummeted 4.18% and 2.89% respectively on Feb 4 while the Dow Jones Industrial Average tumbled 2.61% on Feb 3.

In the coming months, The Edge will discuss various issues and attempt to provide insights, analyses and understanding.  In every issue of The Edge this year, The State of the Nation column will highlight recent developments by updating and analysing further the charts used in the original report.  This will help you keep track of the key variables to assist you in making informed business and investment decisions.

Real interest rates turn negative

Malaysian households are grappling with a rise in the cost of living and the effects are beginning to show, ahead of much bigger price hikes expected this year.

Today, we look at what the inflation numbers and, incidentally, Public Bank’s latest results tell us.  The worst is yet to come in terms of rising prices, yet we are already seeing negative real interest rates and stress emerging in some households.

Negative real interest rates arose after inflation outpaced deposit rates in Dec 2013.  This means inflation is eating the value of money in the bank.

The headline inflation rate in December 2013, as measured by the Consumer Price Index (CPI), rose to a more than two-year high of 3.2% from 2.94% a month earlier and just 1.25% in December 2012 (see Chart 2).  Bank Negara Malaysia (BNM) attributed this largely to the rising cost of food and non-alcoholic beverages.  It should be noted that the CPI is widely seen as understating the “true” inflation rate.

On the other hand, the average 12-month fixed deposit (FD) interest rate offered by banks has stagnated at 3.15% since Nov 2012.  (BNM) has kept the overnight policy rate at 3% since May 5 2011.

Based on the difference between the 12-month FD rate and the CPI, savers are now being punished with a negative real interest rate of 0.05%.  The gap becomes wider if we take into account savings with shorter tenures.  The average one-month and three-month FD rates are 2.91% and 2.97% respectively while tiered saving accounts typically yield less than 1%.

As highlighted in Chart 3, positive real interest rates have been declining over the years.  Low interest rates, combined with rising inflation and a flow of foreign funds into the region, helped asst prices rise in the past.

Interestingly, inflation has crept up even before the major price hikes expected this year.  A 14.9% average increase in electricity tariff took effect in January.  Housing, water, electricity, gas and other fuels alone constitute 22.6% of the total CPI weightage.

A higher electricity cost will have a cascading effect, raising the cost of virtually all goods and services.  As the government rolls back subsidies to trim the country’s budget deficit, the prices of essential goods and services are likely to continue rising.  Hence, inflation can only be expected to accelerate.

Will the central bank then raise interest rates to counter inflation?

The consensus is that there will be a 25bps to 50 bps rise in interest rates this year.  Already, emerging markets have started to raise rates in response to inflation, capital outflow and currency concerns.  However, local interest rates are not expected to rise much due to the high level of household and government debt.  That being the case, the trade-off could be a weaker ringgit.

Household stress affecting banks?

At 85.1%, Malaysia’s household debt-to-GDP ratio is the second highest in Asia.  As households become increasingly squeezed by high inflation and low wages, their ability to repay loans or borrow money comes into question.  For banks, this could mean higher non-performing loans and slowing loan growth ahead.

As banks start to announce their results for 2013, they will no doubt come under scrutiny for initial signs of household stress.  Nonetheless, any major impact on bank earnings will likely only emerge later in the year or in 2015 due to the lag in recognising non-performing loans and the disbursement of previously approved loans.

Public Bank released its results for 2013 last week, the first bank to do so.  Being Malaysia’s second largest lender and with 93.3% of its loans disbursed domestically, it can be seen as a bellwether in the domestic banking sector.  Well known for its high asset quality and prudent management, Public bank has the largest proportion of household loans among local players.

A quick look at its earnings shows commendable loan and profit growth in 2013.  Its domestic loans grew a robust 12%, gross impaired loans ratio (the key measure of asset quality) declined to 0.67% from 0.69% while net profit grew 6.2% to RM4.06 billion.

However, it also shows early signs of stress in the household sector.  Public Bank has very low levels of impaired loans, but the proportion of its household impaired loans compared with total impaired loans increased over the past year – from 63.1% to 70.8%.  This was despite its household loans being maintained at 63.8% of total loans over the last two years.

In 2013, Public Bank’s impaired household loans grew 21.1% outpacing the 11.8% growth in total household loans.  A quick calculation shows that the gross impaired loans ratio in its household portfolio increased from 0.69% in 2012 to 0.74% in 2013 despite an overall decline – from 0.69% to 0.67% -- in total loans.

To be fair, Public Bank’s impaired loan ratios are very low and should not be a concern to its shareholders.  However, they do imply that Malaysian households are starting to feel the pinch.                                                             E