Last week, an economic analyst and “anti-economic bubble activist” (whatever that is) Jessse Colombo wrote a piece for Forbes (republished on Moneyweb on Monday) saying that South Africa is in the middle of a major credit bubble, and that the bubble is about to burst. The piece has generated a lot of debate, and since reading it, I have been mentally arguing with Colombo on some of his points. So, today, to vent my spleen constructively, I have decided to hop aboard the band wagon and share some of my thoughts on his arguments.
For the few of you who haven’t read the piece, his argument is basically that South Africa is in the middle of credit bubble – evidence for which includes all-time low interest rates, surging private loans, rapid house price growth, a too-large financial sector, soaring government debt, and a sizeable current account deficit – which will soon burst, wreaking havoc on the lives of South Africans and those who have invested in the country. It’s definitely worth reading the whole piece, and he makes many good points, but there are a few counter points which I think are worth noting before we buy into the argument wholesale.
1. Is the debt-to-GDP ratio really that scary?
It’s true that South Africa’s government debt-to-GDP ratio has grown sharply over the last four years, (see chart below). However, let’s put this into perspective.
First, South Africa’s ratio is in line with other developing countries. The chart below shows debt-to-GDP ratios for several countries that are comparable to South Africa in that they have similarly sized economies and are considered to be upper-middle-income. As you can see, South Africa’s ratio is not higher than average. Second, South Africa’s debt-to-GDP ratio is (just barely) below the upper limit of 40% that the IMF recommends for developing countries.
Yes, the rise in government debt is a point of concern, particularly as a lot of the spending has been on things like welfare payments rather than productive investment. Yes, rising rates anda weakening rand mean that the debt burden will feel more onerous over the next few years. And yes, it’s important for government to demonstrate that they have a plan to manage their debt. However, it is not clear that South Africa is at a crisis point in terms of its government debt as the author implies. (As an aside, it’s worth noting that most rich countries are well above the IMF-recommended 60% ratio – the US is at 101%, Japan is at 227%, and the UK is at 88.7%.)
2. Household indebtedness is less worrying than you may think
The article makes a meal out of South Africa’s rising levels of household debt, particularly the rise in unsecured lending. It is certainly true that unsecured lending has been growing rapidly, but it’s from a very low base. The chart below shows details on credit extended each quarter in SA. It’s a bit busy, but you can see that despite its rapid growth, unsecured lending still forms a relatively small proportion of the credit granted in South Africa each quarter – it has increased from 7.75% in Q4 2007 to 17.8% in Q3 2013 (and, importantly, it’s down from its Q4 2011 high of 24.6%). In addition, the ratio of unsecured debt to total household debt has hovered around the 13% mark since early 2013, making it seem less scary than it first appears.
Furthermore, overall household indebtedness is actually down from its earlier peaks. As you can see below, after its Q4 2008 high of 81.9%, the household debt to disposable income ratio in South Africa fell to 74.3% in Q4 2013. Compare that to the ratio of around 130% in pre-crisis America and you can see that South Africans are not really in over the heads.
It is worrying that there is so much debt in the system, but South Africans do appear to be making an effort to pay down their debts already, helped out by the reasonably good real income growth they have enjoyed since 2009. Consumers are under pressure, yes, but they are not yet in crisis.
1. The house price story is a little more complex than that
Colombo argues that house price growth in South Africa has been crazy since 2004. I think this is a little simplistic. For a start, if you actually look at the Economist data he quotes (subscription required), you see a pretty varied historical picture. For a start, South African house prices behaved badly from the mid-80s to the early 2000s. Odd right? Well, not really when you consider the political uncertainty that was a major factor in those prices. In real terms, South African house prices declined from around 1984 to a nadir in 1995 or so, then slowly began increasing. They only reached pre-1984 levels in 2006 – in other words, zero growth for about 20 years. Prices have doubled since 2000, but if you compare 2013 prices to 1980 prices on an index, they have grown about 40%. In other words, a lot of the growth in SA home prices is actually normalisation after political upheaval. The chap uses data pretty selectively, I think.
Further, the Economist data uses indexing. Another way to look at it is in terms of average house prices. As you can see from the chart below (taken from http://housepricesouthafrica.com/real-house-prices/, and based on Absa data), in real terms (adjusted for inflation, constant 2012 prices), South Africa houses are currently worth about 19% more than they were in 1983. Considering the dramatic improvements in the domestic economy and political situation since then, this really does not seem like bubble territory to me.
Finally, if you look at the Economist’s price to rental data, it’s pretty clear that you can still rent out a property in SA for more than you pay for it, a clear indicator that house prices are not in bubble territory.
There are a few other concerns I have with the Forbes piece, including the fact that he often compares real to nominal measures, which is not appropriate or meaningful, and that he fails to compare South Africa to similarly structured peers – it’s hard to tell if a lot of this stuff is bad without knowing if we’re doing better or worse than other, similar countries.
Colombo makes many good points. South Africa is entering a period of higher interest rates with a lot of debt. The rand’s weakness is hurting our ability to pay off our foreign debts. Consumers have borrowed a lot, and banks are exposed to bad debt risk. However, consumers have been steadily reducing their debt to income ratio since 2009. House prices have fallen in real terms since 2008. Government debt has increased, but remains within manageable levels. There are risks, certainly, and the next few years will be tough. But it just doesn’t look like a credit bubble to me. What do you think? Let me know below.