Economic commentary provided by Alberta Central Chief Economist Charles St-Arnaud
Household indebtedness has been a major concern and risk for the economy for some years. After a sizable improvement in 2020, households’ debt-to-disposable income ratio remains below its pre-pandemic level in the third quarter at 177% despite rising debt levels, as disposable income continues to be supported by government programs. Government transfers represent about 23% of household disposable income currently; before the pandemic, it was 18% (see Fig 5). We estimate that if government transfers were to normalize, disposable income would be 4% lower than currently and the debt-to-disposable ratio would jump to 185%, its highest level ever.
Similarly, the debt-service ratio also improved during the pandemic thanks to the impact of the government support program on disposable income. Despite the rising debt level, the debt-service ratio eased to 13.3% in the third quarter due to an increase in disposable income and lower interest payments. A normalization in government transfer would push the debt-service ratio to 13.8%, still below its pre-pandemic level thanks to low interest rates.
The impact of the government’s income-support measures on household finances since the start of the pandemic raises concerns regarding households’ ability to service their debt when those programs are phased out or when interest rates go up. Such a normalization is likely to be a headwind on consumer spending, as households will need to divert some of their income from discretionary spending to debt repayment. However, households have accumulated a significant amount of saving during the pandemic, about $340bn. Whether they spend, repay their debt or keep that amount as saving will matter for the outlook.
The ratio of household debt to disposable income increased slightly in the third quarter, rising to 177.2%, still lower than the pre-pandemic level of 180.6%. This means that for each dollar earned, households owe on average $1.77 in debt. The ratio deteriorated as a result debt increased at a faster pace than disposable income (2.0% quarter-over-quarter vs 1.8% quarter-over-quarter).
The increase in disposable income was the result of an increase in compensation of employees (+1.4% quarter-over-quarter) while government transfers declined (-1.6% quarter-over-quarter), as the amount of government support decreased due to the reduced generosity of government programs. Since the start of the pandemic, the increase in government transfer has been responsible for about a quarter of the rise in disposable income.
On the debt side, the increase in total household debt was mainly due to a rise in mortgage debt (+2.5% quarter-over-quarter), while non-mortgage debt saw a more modest rise on the quarter (+0.7% quarter-over-quarter), with both non-mortgage loans and consumer credit contributing.
Since the start of the pandemic, household debt to disposable income has declined by 3.9 percentage points (pp). The improvement in the indebtedness ratio is entirely due to the increase in disposable income, which reduced the ratio by 20.1pp. However, a continued rise in the level of debt, push the ratio higher by 18.2pp.
The debt-service ratio, the share of income households need to spend to repay the interest and obligated principal payment on their debt, edged lower to 13.3% from 13.5%. This means that for each dollar earned, households need to spend $0.13 to service their debt. The reduction resulted from the increase in disposable income, reducing the ratio by 0.2pp, while higher debt payment contributed +0.1pp to the ratio.
The details show that the rise in debt payment resulted from an increase in the obligated payment of principal (+2.5% quarter-over-quarter), as the debt load continues to increase. With interest rates remaining low, interest payments declined on the quarter (-2.3% quarter-over-quarter), likely as households managed to refinance some of their existing debt at lower rates.
Since the start of the pandemic, the debt-service ratio has eased by 1.7pp, with 0.2pp of the decline coming from lower debt payments and 1.5pp from higher disposable income. The decrease in debt payments over the period is entirely due to lower interest rates, as principal repayment increased in line with rising debt levels. This suggests that, as interest rates increase, a greater share of household income will need to be diverted towards interest payments, likely reducing discretionary spending. Moreover, the details show that only non-mortgage debt contributed to the lower debt-service ratio, as mortgage debt continued to increase over the period.
The household saving rate declined to 11.0%, its lowest since the start of the pandemic. The lower saving rate was due to a bigger rise in consumer spending than in income, as the economy reopened over the summer months. According to the national balance sheet data, households have accumulated almost $340bn in saving since the start of the pandemic. Of this amount, about $280bn is held in bank deposits and about $88bn has been invested in equity and investment funds.
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