Emerging market consumer credit risks

Given the chance, consumers around the world act more or less the same. Credit card abuse is a universal past-time. But this time the credit bubble is no longer in the US

Spend, spend, spend! It seems that is all Americans consumers do. They happily buy the latest appliances, second or even third cars and every electronic device known to man. In fact they spent so much they eventually caused a global meltdown.  Before the crash they leveraged up their spending using overvalued real estate as collateral and created a huge credit bubble. When the housing market started going down instead of perpetually going up, they found that the household debts they had created could not be paid back.


In contrast, there are all of those thrifty people in emerging markets. They save vast amounts of money that can be used for investments in growing economies. With strong family traditions, they eschew debt in any form. Or do they? Actually they don’t. Given the chance, consumers around the world act more or less the same. Credit card abuse is a universal past-time. But this time the credit bubble is no longer in the US.


Consumer debt meltdowns are not exceptional in Asia. Before the American crisis, there were three. Over the past 15 years Hong Kong, South Korea, and Taiwan have all experienced excessive household debt which threatened the stability of their financial systems. But these countries and their issues were relatively small and localized.


The combination of rapid economic growth in emerging markets, combined with trillions in stimulus money and the search for yield has provided borrowing opportunities never before available to millions. The result is that non-mortgage consumer credit in Asia outside Japan rose 67% in the past five years. It now amounts to over $1.66 trillion. Car, motorcycle, appliance and electronic loans all more than doubled while credit card loans grew 90%. These issues are no longer small or local.


But is this a problem? Overall, consumer debt in Asia is far lower than in many more developed countries. The difference is income. As a percentage of income, debt burdens in Asia are up to 30% higher than in the US. Overall, debt burden relative to GDP is higher in India, Indonesia, Thailand, South Korea, China and Malaysia. It is only less in than the US in Taiwan and Hong Kong, two of the countries that have experienced consumer credit problems.  


One of the most vulnerable economies is Malaysia. Unusually, strong economic growth has led to an explosion of consumer credit. Consumer debt is approaching developed world levels. Malaysian household debt has risen to 76.6% of GDP from 65.9% five years ago. It is the highest in the region. Malaysian consumer boom has followed the country’s economic expansion. A lot of this expansion has been due to commodity producer exports to China.


Much of the credit has been due to the inflow of money from developed countries specifically the QE program of the US Federal Reserve. With China slowing and the QE program ending, consumers specifically and the Malaysia economy as a whole may be vulnerable. But they aren’t the only ones.


Indonesia has also benefitted enormously from the export of its mineral wealth to China. Indonesian non-mortgage consumer credit nearly tripled in the last five years. Domestic consumption has become the other main driver of Indonesian economic growth and has been driven by easy access to credit cards. The central bank has belatedly realized the danger and is trying to rein in credit by imposing minimum down payments for car and motorcycle loans. But unlike some of the other South Asian countries, Indonesia manufactures essentially nothing. That makes it particularly vulnerable when the two main sources of economic stimulus, commodities demand and cheap money, dry up.


It is not just its trading partners that are at risk as China slows. The main beneficiaries of China’s financial systems have been local governments and unprofitable state owned industries. Still consumption and consumer credit have also grown at a spectacular rate. Credit cards were first introduced into China in 1985. There are now 320 million credit cards in circulation. Like other Asian countries this number has exploded recently. Since 2006 the number of credit cards has quintupled. Growth is projected to increase by another 31% in the next five years. The number of credit card purchases represents almost 40% of all purchases. In 2011 the number of purchases was $1.2 trillion a 48% increase over the prior year.


The potential catastrophe from credit card defaults is huge, but it is exacerbated by a particularly the Chinese issue, the control of information. Credit agencies in most emerging markets are still in their infancy which makes consumer lending riskier than in developed countries. This is especially a problem for China where the only source of credit information is the Credit Reference Service of the central bank—the People’s Bank of China. Private commercial credit agencies are allowed to operate, but they are not allowed access to bank and public sector information. As someone familiar with mistakes on my own credit reports, which are different for each of the three credit agencies operating in the US, I can only imagine the vast errors inherent in the Chinese data.


The dangers of consumer debt in emerging economies are particularly well illustrated by South Korea and Brazil. Korea has already suffered from one consumer credit meltdown, but is now at risk of another. It has problems that are in a way similar to the US. Since the crash US consumers have been deleveraging. US share of debt payments to disposable personal income has fallen to 10.38%, the lowest level since 1980. The one exception is student loans. The amount of outstanding student loans is now more than $1 trillion, making them the largest category of consumer debt in the US aside from home mortgages. Worse, 11% of these loans about $110 billion are now seriously delinquent, meaning at least 90 days past due. In 20003 the number of delinquencies was only 6 %.


In Korea families also borrow heavily to send their children to university. Total household debt is now 959.4 trillion won ($844 billion). In 2011 it reached 164% of disposable income compared with 138% for Americans before the recession. It is now the biggest risk to the Korean financial system.


Like Indonesia, Brazil is also experiencing a credit boom. The country has developed a culture of instalment payments or parcelas. Almost anything from shampoo to plastic surgery is available on instalments. The result is that the average family spends 20% of its monthly income paying off debt, handily beating American consumers who reached a record of 13.5% in 2007 and twice the present rate. The Brazilian economy is slowing and the defaults are, not surprisingly, rising. Overall loan defaults rose to a record 5.9% at mid-year 2012. Due to tighter lending they improved a bit by last December, but only slightly, to 5.8%. At the end of 2011, they were 5.5%. Like China, to stimulate the economy, the state-owned banks have been ordered to increase lending. Their market share increased from 47.6%, up from 43.5% in 2011. No doubt their share of defaults will increase as well. Like Indonesia and Malaysia, Brazil is heavily dependent on Chinese demand for commodities. China edged out the US as Brazil’s main trading partner. So a Chinese slowdown will hurt Brazil and its over leveraged consumers as much if not more than countries in Asia.


Unlike developed countries emerging markets have been growing rapidly since 2008. While Europe is in recession and the US is barely able to grow at 2%, emerging markets have been racking up 5% and more growth rates a year. It is part of the emerging market investment ‘story’ that these growth rates are based on demographics, exports, high savings and investment rates. People in emerging markets were supposed to be far more frugal and avoid debt. So both household and national debt levels were much lower. All of this was supposed to add up to rapid recession free sustainable growth.


But as it turns out, many of these countries and their citizens were just like their more developed counterparts. When introduced to cheap credit, thanks in part to central banks, they happily took advantage of it, to their and their countries’ financial systems’ detriment. Growth rates in emerging markets have been falling since 2010. The slowing of the world economy, especially in China, and the end of free money will no doubt increase the trend. At the end of the day emerging markets will be found to be just as susceptible to credit crisis and business cycles as everyone else, perhaps even to a higher degree.  


(William Gamble  is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)

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