Are Loans Destroying or Uplifting the SA Economy?

Mar 07, 2016
Author: Ean Barnard

There are various variables that impact the growth of the South African economy, and debt - more specifically consumer debt - is one of them. Consumer debt is the type of debt held by individuals and incurred through, among other things, loans from banks and loan providers such as Absa, FNB, Boodle and Better Life. Consumer debt can have a positive impact on the South African economy, but when not managed well it can also be a heavy burden that drags South Africa back. This is why Responsible Lending has become a ‘feature’ from many institutions offering loans.

Economic Growth caused by Increased Consumer Debt

The economic growth that is stimulated by increased consumer debt can be explained with the Multiplier Effect. When consumers borrow money to finance their consumption, the funds are injected into the economy, increasing consumer spending. This increased consumer spending results in increased business revenues, that enables businesses to create more jobs. With more jobs being created, individuals have more spendable income which results in increased consumer spending and so, the cycle continues. This ultimately results in economic growth.

Another positive aspect of loans is when it is used to finance bigger homes, through home loans and mortgages. These loans are used to purchase appreciating assets and as house values increase, it results in an increase in consumer wealth. This reduces the risk of default, as the consumer’s equity is built into the home and if a consumer cannot pay back their home loan with their day to day cash flow, they can pull some of the equity out of their home or sell the house at a profit to pay back the loan. This is, evidently, a very healthy way of using loans and credit to advance South Africans and the South African economy.

When Borrowing turns Bad

The problems with loans come in when consumers borrow to finance consumption that is bigger than their income. The difference between a consumer’s domestic income and household spending is, therefore, financed by bank credit and consumers have to borrow more and more to sustain their increased levels of consumption - as they cannot do this naturally with their own income. This increases debt levels and creates the burden of increased interest payments, which also comes at a higher rate when financing consumption through unsecured loans. The initial growth in consumption and spending in the economy inevitably slows when households attempt to reduce their debt by spending less than before. This has a sharp effect on short-term economic growth, but also puts a brake on future economic growth. When debt levels are high and interest rates rise, it causes the further problem that more of a household’s spendable income is needed to service the debt than before, resulting in even less spending in the economy.

 

A good example of when borrowing, even when loans are used to finance homes, turns bad is the Great Recession during 2008 - 2012. When the housing market in America slowed down, housing prices dropped and interest rates started rising. Borrowers were no longer able to pay their loans back, which resulted in a quick rise in foreclosures and bankruptcies and banks having to write off large amounts of bad debt. This chain reaction triggered the Great Recession that had a drastic impact on economies worldwide. Loans and responsible consumer debt can have a very positive impact on the South African economy and cause short-term economic growth. But this can only last as long as consumers can actually afford to pay back their debt.

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