The drop in the debt-to-disposable income ratio reported by Statistics Canada may not paint an accurate picture of the country’s debt profile. The ratio fell from 175.4 per cent to 158.2 per cent in the second quarter of 2020, though one economist says government supports coming to an end could present risks to groups that have been disproportionately affected by the pandemic.
Josh Nye, a senior economist at RBC, says the debt-to-disposable income ratio, while a popular barometer to determine household debt in the country, is not his favourite metric to use. Nye says that in this case, the shift in the second quarter was less about Canadians paying down their debt and had more to do with a jump in disposable income from government supports during a shock to the labour market.
“The government income support programs - particularly the Canada Emergency Response Benefit - more than made up for lost wage income in the second quarter,” Nye told Yahoo Finance Canada, “So, you have an 11 per cent increase in disposable income and that pushed that debt-to-income ratio sharply lower.”
Nye remains optimistic about the continued government supports during the recovery announced in late August, including the Canada Recovery Benefit that offers $400 to the self-employed who are not eligible for employment insurance, the Canada Recovery Caregiving Benefit, and the Canada Recovery Sickness Benefit. “The extension of those benefits has reduced our concerns about a debt cliff coming in the fall.”
Nye added that the current low interest rate environment means there’s less of an incentive to pay down debt moving forward. High household debt typically brings a concern that income allocated to servicing this debt could put a drag on economic consumption – a drag that could prolong the recovery as many businesses find their footing again. A Bank of Canada report in June found that even before the pandemic, household consumption was slowing as consumers became more cautious, “perhaps because of elevated debt levels and a somewhat less robust economy.”
"Are they going to use that to pay down their debt? Are they going to just save it and invest it?" Josh Nye, senior economist, RBC
Many Canadians who kept their jobs managed to accumulate ‘forced savings’ once they began working from home, curbing regular expenses like travel, eating out, and dry-cleaning. Nye says their behaviour could range from spending in a bout of pent-up demand or continuing to save their income instead.
“For those people, the question is: are they going to use that to pay down their debt? Are they going to just save it and invest it? Or will they eventually spend it and [we'll] get some pent-up demand… that could be a nice boost for demand.”
However, Nye also pointed out that the pandemic hasn’t impacted all Canadians equally. In his report for RBC, he described how residents of oil-producing provinces and younger households were at a greater risk of insolvency. The report explained that Alberta households had a higher average debt-to-income ratio at 208 per cent compared with the 182 per cent for the rest of Canada in 2018. For Millennials, the report described how rising house prices prompted this cohort to take on more debt to get a foothold in the real estate market. Canadians aged 25 to 34 held an average debt-to-income ratio of 216 per cent, being 1.7 times that of Generation X and 2.7 times the ratio of Baby Boomers when they were the same age.
Nye explained that the pandemic job losses have not impacted everyone equally, pointing to the many Canadians who have had to rely on income supports like the Canadian Emergency Response Benefit (CERB) during the crisis. “Generally, it does look like some households are going to have a bit more difficulty keeping up with their debt payments over the next year as those benefits become less generous and deferrals expire,”
Scott Terrio, manager of consumer insolvency at the Ontario debt relief firm Hoyes, Michalos & Associates, echoed this concern. “The service jobs tend to be younger people, so they've had a hard time,” Terrio told Yahoo Finance Canada, adding that many are moving apartments to find cheaper housing amidst softening rent rates.
"Banks are not your friend." Scott Terrio, Hoyes, Michalos & Associates
In a return to normalcy, Terrio believes that the ‘forced savers’ who kept their jobs during the pandemic may be more inclined to spend. However, there remain some vulnerabilities on the debt horizon as courts re-open and banks resume collection activities. “I think you're going to see collection activity ramp way up, the banks are going to be out for blood.”
The end of deferrals and supports could mean added pressure for those carrying debt into the recovery phase of this crisis.
“I just think people need to understand that banks are ruthless, banks are not your friend,” Terrio said, “It is a business transaction and you will find out exactly how much your bank loves you soon.”