ECONOMY

Rising debt of Greek households not an especially worrying prospect

The nearly certain prospect of an increase in the official interest rate by the ECB (European Central Bank) in the near future and the possibility of more rate hikes over the next few quarters have brought the issue of indebtedness of Greek households front and center. Although the popular notion has it that heavy indebtedness has gripped hundreds of thousands of Greek households, this is not correct. Despite a pickup in consumer and mortgage borrowing in the last few years, Greek households remain under-leveraged compared to their peers in the eurozone, while pockets of indebtedness in urban areas should not lead to simple generalizations as long as the economy keeps on growing at a satisfactory clip. The issue came to the forefront again last week when central bank governor Nicholas Garganas revealed that 8.8 percent of all consumers and 4.5 percent of mortgage loans are in arrears. With more than 2 million people estimated to have taken out a loan, mostly a floating rate one, household indebtedness is definitely a hot topic in view of projected ECB rate hikes. The European Central Bank is expected to raise its official rate to 2.5 percent in early March from 2.25 percent at present. It bears remembering that the ECB hiked its intervention rate by 25 basis points to 2.25 percent in early December 2005 after keeping it at 2.0 percent for a long time. The market expects the central bank of the eurozone to raise its official rate to 3.0 percent by end-2006, a move which is bound to increase the cost of borrowing if it is confirmed. Despite the double-digit growth in retail loan volumes over the last few years, there is no question that Greek households remain under-leveraged overall compared to their peers in the eurozone. According to Bank of Greece figures published last August, the sum of consumer and mortgage loans outstanding stood at 32.5 percent of GDP in Greece compared to 51.4 percent on average in the eurozone. Moreover, some 50 percent or more of Greek households appear not to have taken out a single loan, ever. The pickup in retail loan growth in the last few years has been the natural offspring of a number of factors. The entry into the eurozone provided Greek families and individuals with their lowest lending rates in generations. It was further bolstered by the full liberalization of consumer credit by the Bank of Greece in 2003 and supported by the country’s strong GDP growth rates in excess of 3.5 percent on average and the subsequent rise in real disposable incomes. Nevertheless, to the extent that the Greek economy continues to grow at more than 3.5 percent this year and next, and given the still relatively low level of loan penetration, one would expect a slowdown in consumer and mortgage lending but nothing close to a halt as long as the ECB’s official rate did not rise above 3.0 percent this year. Even the ECB’s campaign to raise its interest rate would not have caused much concern were it not for the fact that over 90 percent of retail loans are based on the ECB’s official rate, the interbank Euribor rate and the so-called base interest rate offered by Greek banks in the past. The base rate is adjusted by the banks using their own criteria. Floating or fixed rates? Greek households’ love for floating-rate loans, especially in the mortgage category, is easily explained by the fact that these were cheaper than long-term fixed rate loans of 10 to 20 years. However, this attachment also highlights a potential problem: the inability of a good number of borrowers to understand the difference between a floating and a fixed rate loan in the long run. On one hand, this is understandable because there was no borrowing culture in the country previously, but on the other hand it is a source of concern because some may find it more difficult to service their loans in the quarters ahead. Realizing the potential harm from a sharp hike in the ECB’s interest rate, local banks have been trying to address it lately by cutting their long-term fixed-rate mortgage loans and urging customers to switch to fixed-rate loans. Still, even if the ECB hikes its official rate by 75 basis points to 3.0 percent by year-end, we still believe that the situation is a far cry from the disastrous scenarios prescribed by some in the media. Given the background we described before, it is normal to expect strong retail loan growth in a country where under-leveraged households have access to cheap credit perhaps for the first time in their lifetimes. It is also normal to expect that a fraction of these households will have problems servicing their loans, and this number tends to rise as more loans are taken out. Sometimes, unforseen events hit an individual during the time of servicing the loan, while in other cases it is a miscalculation in the individual’s ability to service the loan which ought to be blamed.  Distinction between loans Whatever the case, we believe, one should make a distinction between consumer loans and mortgage loans. In general, most Greek households behave prudently and tend to go to the extreme to service their mortgage loans in order to preserve their houses. Moreover, mortgages, which represent the majority of retail loans in Greece, are covered by real assets. This means a mortgage loan does not by definition equal debt for a household, since the value of the underlying asset may exceed the value of the remaining loan. This by itself weakens the argument that Greek households have become heavily indebted. Contrary to that, the vast majority of households servicing their mortgage loans see their wealth increasing as the time passes. Instead of becoming more indebted, as the popular notion has it, these households become more disciplined, one may even say more European, and wealthier.  Admittedly, the same is not true, at least to the same extent, with consumer loans, even those intended for the purchase of durables such as cars, refrigerators, furniture and others. So the scope of household indebtedness should be limited even more to this category of loans, enhancing our main argument. All in all, its natural to expect a pickup in credit growth to be accompanied by an increasing number of loans in arrears, especially in a country like Greece, where underdevelopment of the borrowing culture is a fact. It is natural to expect that this trend will continue as long as the Greek economy grows at a fast pace and euro lending rates do not rise sharply in a short of time, which is rather unlikely. It is also fair to expect that there will be pockets of heavily indebted households, especially in urban areas, where most borrowers live and work. But this does not in any way constitute a severe problem of household overindebtedness as portrayed by some in a country where 50 percent of the population has yet to borrow and retail loan penetration lags behind the EU average. This is not to mention the share of wealth-enhancing mortgages in the total retail loan pie.