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Private debt in the Eurozone is still a liability

Economic Comment

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  • Despite recent deleveraging, private sector debt remains high in many Eurozone countries. In most of them, private debt remains above levels deemed damaging for long-term growth
  • Also, broadly speaking, debt among non-financial corporations seems more of an issue than household debt
  • Whilst average vulnerability of the private sector to higher interest rates has decreased in recent years, several countries, in particular the former bailout countries, Cyprus, Greece, Ireland, Portugal, and Spain, plus Finland and Luxembourg require ongoing attention. Notably, private sector debt in Italy seems to be (much) less vulnerable

The view from the (debt) mountain

Figure 1: Eurozone private debt on a downward path, but still near all-time highs
Figure 1: Eurozone private debt on a downward path, but still near all-time highsSource: Macrobond

High and rapidly increasing private debt was one of the main causes of the Eurozone crisis. It certainly choked spending in some Member States when the downturn in 2008 set in. Since its peak in early 2015, aggregate Eurozone private debt has finally come down, but it is still higher than in the years prior to the financial crisis: 161% of GDP end 2017 vs. 152% of GDP early 2008 (figure 1).

In the Special Can private debtors in the Eurozone weather interest rate shocks we explored whether private debt still poses a risk to economic stability, especially if and when interest rates start to rise. We looked at a number of indicators that are associated with interest rate sensitivity such as debt affordability, maturity profiles, headroom in savings and the availability of liquid assets.

Footnote
[1] In especially Ireland, Luxembourg, Malta and Belgium (Netherlands, Latvia and Slovenia to a lesser extent) data on corporate debt likely overestimates the debt burden on the economy. A relatively high amount of loans supplied by non-domestic counterparties is likely to be caused by either the international banking sector setup and/or debt reporting for tax reasons.

Risks have reduced, but several countries still require attention

We have come to the conclusion that despite recent deleveraging, private debt remains above levels deemed damaging for long-term growth in many Member States (figure 2 and 3). Cecchetti et al. (2011) argue that total private debt above 100%, household debt above 85% or debt of non-financial corporations above 90% has a negative effect on economic growth. Broadly speaking, debt at non-financial corporations seems more of an issue than household debt.[1]

Figure 2: Most countries still above 100% threshold…
Figure 2: Most countries still above 100% threshold…Note: Data is from 2017Q3, only in Slovenia data is from 2017Q1
Source: Macrobond, Rabobank
Figure 3: Debt among non-financial corporations seems more of an issue than household debt
Figure 3: Debt among non-financial corporations seems more of an issue than household debtNote: Slovenia data is from 2017Q1
Source: Macrobond, Rabobank

More specifically, while we found that average vulnerability of households and non-financial corporations to higher interest rates has decreased in recent years, several countries, require ongoing attention. In particular this concerns the former bailout countries, Cyprus, Greece, Ireland, Portugal, and Spain, plus Finland and Luxembourg (although the non-financial corporate debt data especially for Luxembourg, but also Ireland is likely to be skewed due to a relatively high amount of ‘non-domestic loans'). Notably, in Italy private sector debt seems to be (much) less vulnerable (table 1).

Household debt challenge has decreased, but vulnerabilities remain

In most Eurozone countries household debt service ratios have declined when compared to the year just before the crisis and, hence, affordability has improved. In neither country the average household debt service ratio nears the 40% vulnerability threshold advocated by institutions such as the BIS. Although, the ratio for low-income households in Southern Member States, Slovakia and Estonia does.

One specific vulnerability to interest rate shocks is the share of short-term loans and/or loans with an interest rate reset over the next 12 months. This share is highest among households in Finland, Malta, the Baltics, Portugal and Spain. Based on their (relatively) low active saving rates and (relatively) high debt service ratios we expect that especially households in the former bailout countries and Finland would have to cut consumption to service debt if debt costs were to increase. The availability of sufficient liquid assets (currency and deposits) is one factor that could mitigate the initial impact on consumption, although it is difficult to draw conclusions in this respect based on average data figures.

Corporate resilience has significantly improved but is still rather weak in certain countries

Since the crisis, interest coverage of non-financial corporations in the Eurozone has also improved significantly, making businesses less vulnerable to income and interest rate shocks. But there are huge differences. Non-financial corporations in Cyprus and Luxembourg as well as in Portugal, France and Estonia, still seem more vulnerable than their European counterparts (although the data especially for Luxembourg is likely to be skewed due to a relatively high amount of ‘non-domestic loans'). Vulnerability to interest rate shocks (when only focusing on interest rate resets) is relatively high in Finland and the Baltic states, but when we include short-term debt, most former ‘problem’ countries are also more vulnerable than the average. The relatively low debt to GDP and debt to income ratios in the Baltics should limit the overall impact on the economy.

Table 1: Heatmap for household and corporate sensitivity to interest rate shocks
Figure 4: Heatmap for household and corporate sensitivity to interest rate shocksFor explanation on ranking see 'Can private debtors in the Eurozone weather interest rate shocks' 
In the Netherlands, interest payments on mortgages are largely tax deductible. As such, we have made a rough calculation of what share of interest payments is tax deductible and consequently have adjusted the debt service ratio and the active saving rate.
A heatmap does not always allow for the necessary nuances in comparisons. For example, the non-financial corporate debt data for especially Luxembourg, but also Ireland, is likely to be skewed due to a relatively high amount of ‘non-domestic loans'. And the high household debt ratio in the Netherlands, has its counterpart in high pension wealth. Though it still helps in spotting patterns and getting an overall picture of where risks might be most prominent.
Source: Rabobank

References

Stephen G Cecchetti, M S Mohanty and Fabirzio Zampolli (2011), “The Real Effects of Debt”, BIS September 2011.

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Author(s)
Maartje Wijffelaars
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 68740
Elwin de Groot
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 69012

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