Contemporary Issues in Economic Development of Small States 1 Some Implications of Credit Spending:...

Contemporary Issues in Economic Development of Small States

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Some Implications of Credit Spending: A Brunei Case Study

Dr Teo Siew Yean &

Mr Gabriel Yong


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Definition of “Consumption”Definition of “Consumption”

Consumption is normally the largest Gross Domestic Product (GDP) component

There are two definitions of consumption. First, consumption may be divided according to the durability of the purchased objects, for example, durable goods (such as cars, refrigerators, televisions)

non-durable goods (such as groceries) and services (laundry service, restaurant expenditure)


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Why we spend?Why we spend?

consumption is classified according to individual needs, and a commonly defined classification is:

C = F + CL + Ho + R + U

+ AP + P + WH + E + ET

where =


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We spend on:We spend on:

• (a) food• (b) clothing and foot wear• (c) housing• (d) cars• (e) utility bills• (f) furniture, household appliances and services such

as plumbing services, changing bulbs, etc.

• (g) communication technology and phone, internet bills

• (h) wellness and hobbies• (i) education• (j) entertainment


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How far can we spend:How far can we spend:

Cash (monthly earnings, bonus,

dividends, gifts & charity, winnings, etc.)

Credit (personal loan, car loan, mortgage, credit card)

This empirical model is available upon request...


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Credit Spending?Credit Spending?

Credit is a growing part of our day-to-day lives, especially in urban cities

Most of us have loans, or other credit, which can be managed without difficulty if the person has the discipline to repay a minimal amount every month

Borrowing can be a useful tool to help households smooth their expenditure over time


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Debt Vs Over-IndebtednessDebt Vs Over-Indebtedness

Debt is not the same as over-indebtedness

Debt only becomes a problem when people cannot afford the repayments. It becomes a problem when it turns to over-indebtedness


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Debt Vs Over-indebtedness, cont.Debt Vs Over-indebtedness, cont.

Over-indebtedness has a cost:(a) a cost to consumer in terms of running the risk of personal bankruptcy(b) a cost to banks/creditors in terms of outstanding loans(c) a cost to businesses in terms of profits cut(d) a cost to the Government in terms of debt collection and

enforcement(e) a cost to the overall economy in terms of job cuts and

economic instability


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Credit performance in Brunei:Credit performance in Brunei:

Reported by random phone

interviews, about 45- 50 percent of

Brunei bank customers apply for credit

facilities (personal loan, car loan,

mortgage, credit card/s) from bank

which they keep their savings account


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COMMON ASSERTIONSCredit spending drives economic growth

But credit expansion leads only to short term growth

Credit-spending keeps consumers in perpetual debt


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Comparison between Brunei & Comparison between Brunei & SingaporeSingapore:: Singapore Straits Times (reported 1st

January 2005):

credit card holders = 2.95 million

=> an average 1.2 S’porean owns a credit card/ 1 person owns more than a card

Total credit = 2.64 billion

=> an average of SGD895 amount owed per card holder


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Comparison between Brunei & Singapore, Cont:

•Brunei Fiscal & Monetary Report, 2004 Credit card holders as at Sept 2004= 94,211 => an average of 25 percent of Brunei population owns credit card/s Total rollover credit as at Sept 2004 = 160 million => an average of BND1698 credit card debt per card holder


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The main objective of this paper is to find out how credit consumption affect the economy

CCS = Am – R + I (1)

where CCS = cumulative credit spendingAM = amount owedR is the monthly repayment I is the interest rate charged on amount owed every month

Rt+1 = m.CCSt+1 (2)


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Cont’

A future oriented consumer is more likely want to settle his credit debt promptly so he could avoid to pay huge interest on amount owed and also enable himself to spend more in the future. Consumers in this category are more likely to have higher rate of repayment. There is a direct relationship between R and m.

On the other hand, a present oriented consumer does not mind to pay more on interest rate charges to maintain his spending power. In this scenario, the consumer pays a smaller m and has a high CCS. However, he has to compromise this “high availability to spend” by paying higher rate of interest each month.


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It+1 = [ (0.24/12). (CCS - Rt+1) ] (3)

AS t+1

= Y - CCSt+1 (4) Therefore, available spending, AS

t+, depends on the level of income Y and CCSt+1. We hypothesise that people spent on credit because they believe they can pay off the debt with future earnings.

And as their level of CCS falls, they would tend to save more of theirincome for the future.

Cont’


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Simulation exercise: BND 1,200, credit limit= BND5,000

0

500

1000

1500

2000

2500

Jan-01


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Simulation exercise: BND2,600, credit limit = BND8,000Simulation exercise: BND2,600, credit limit = BND8,000

0

1000

2000

3000

4000

5000

6000

Jan-01


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Simulation exercise: BND3,500, credit limit = BND10,000Simulation exercise: BND3,500, credit limit = BND10,000

0

2000

4000

6000

8000

10000

12000

Jan-01


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Findings from previous figures:

•According to random phone interviews, findings showed that about 70 percent of consumers are disciplined spenders, that is, they do make repayments (fixed - BND40 or minimal - 5 percent) on their loan every month


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However, there are a few implications thathave to take into consideration to prevent the “anaconda” effect:

1.creates a short-term expansionary effect that likely to end up with inflationary pressure or an overheated economic growth that leads to a collapse in profitability. As level of profits fall, employment and retailsales would be cut, and consequently the sluggish economy will bring about excess capacity and rising inventories. The Korean and Chinese economy has resorted to increased consumer spending to revitalise the economy. Unfortunately, the ”fake” wealth will not resolve the fundamental economic imbalances. Instead, the decline in interest ratethat resulted from credit expansion might cause more economic problems


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2.

NOT ALL CONSUMERS (IF AT ALL) BEHAVE RATIONALLY

E.g. Some choose to consume harmful - instead of healthful - substance (eg. cigarette, oily food, artificial favours, etc.) --> conditions that need treatment (at a cost)

Inappropriate choices undermines spending capacity reinforcing indebtedness


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Cont’

3. ACTION AND REPERCUSSION

An irrational act, e.g. gambling and losing a large sum of money, affects other consumers - family and friends are first in line

In an urban setting, large losses send out a destructive wave undermining a larger number of consumer’s capacity to meet their own needs


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4.4.

Closed EconomyClosed Economy Y = C + I + G Y = National Income

C = Consumption spending

I = Investment spending

G = Government spending Increase national income, C


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Cont’

Open economy with internationalTrade• Y = C + I + G + (X - M) where X = values of export M = values of import• If consumers borrow to spend in neighbouring countries, then C will not be recorded fully in our GDP


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1. Credit spending is necessary because of changing needs associated with changing living environment, paradigms and mechanisms for transaction

2. In Brunei, credit spending is unlikely to lead to economic growth because a significant amount is spent outside the local economy (as is evident from the sluggish retail sector over the past 5 years)


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If credit spending is to invigorate the local economy, there is a need to divert spending outside Brunei to within Brunei


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Note: HSBC’s credit redemption scheme is a good start; as is the Economic Planning Unit’s “Brunei Grand Sales”, but needs to co-ordinate with travel industry, retailers, financial institutions at deeper levels of planning to make Brunei a more attractive place to spend


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• Retailers & authorities need to look closer at the range of consumer’s needs without preconception - if local retailers are to supply consumers’ demand


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• Efforts to improve quality of life, nurture and protect the self-esteem and dignity of individuals/groups, protect consumers from environmental threats - added to education on money matters is likely (from our analysis) to create a more conducive condition for credit-driven economic growth


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………. It is not only about how you

spend, it is also about where you

spend.


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Thank you

Endnote: The purpose of this paper is to give implications on credit consumption in small states such as Brunei to see if the current consumption pattern would sustain in the long run, but by no means it wants to motivate consumers to spend beyond their means.

Contemporary Issues in Economic Development of Small States 1 Some Implications of Credit Spending:...

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