Leverage, Debt Service and Increased Consumption
On the aggregate demand side, the driving force of the economy is the expansion of household consumption, which is being strongly stimulated by monetary policy, in particular the persistently low market real interest rate. That stimulus comes not only from the preference for present over future consumption (the aggregate demand channel) and the lower cost of bank loans (the credit channel). It also comes from the reduction of the debt service ratio, which is the proportion of disposable income allocated to pay the principal and interest on loans.
Although the stock of household debt of in Brazil is under half the figure in the United States, so that Brazilian households are less leveraged than their American counterparts, due to a combination of shorter maturities and much higher interest rates the debt service ratio is much higher in Brazil. We show in this report that with the SELIC rate holding steady at 7% a year for a long period (throughout 2018), the debt service ratio will decline significantly, from the current 21% to around 18% of disposable labor income at the end of 2018. From the standpoint of households, the capacity to take on debt to consume will grow, and from banks’ perspective the risks of default will fall.
The decrease of the debt service burden is helping to sustain the recovery of consumption, and will continue being the most important driving force in the current phase of the Brazilian economy’s recovery.
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