India’s household debt no cause for alarm

Households serve two roles in an economy: as consumers they contribute to demand; as savers they contribute to the level of investment that can be domestically financed. A healthy mix of consumption and saving is desirable. However, during recessions and slowdowns, consumption assumes more significance.

Recession influences households to save more for an uncertain future. When many households postpone their purchases, there could be less aggregate demand, shrinking the top-line of the supply side (firms, big and small). Moreover, the savings channelled into the financial system do not find enough productive investment opportunities — firms have no reason to invest, they have excess capacity already. Inventories pile up and firms cut down production.

The financial position of households influences their consumption patterns. Suppose, the average household has large savings and low indebtedness. Then the return of normalcy could trigger a new wave of consumption. Government initiatives like tax cuts and cash transfers might act as further behavioural incentives.

However, highly indebted households with inadequate savings would not have the ability to spend even if normalcy is restored. The role of government is not only to influence consumption behaviour but also to increase household spending power.

In this context, the quarterly trends of household debt and savings numbers published by the RBI offer important insights regarding the financial position of households.

While similar data for later period is awaited, Q1 FY22 might have seen an increase in household financial savings, in addition to a deceleration in accumulation of liabilities (like Q1 FY21). The health impact of the second wave of Covid-19 in India was more severe compared to the first. However, the following factors helped alleviate the pain in economic numbers during Q1 FY22:

There was no blanket national lockdown — State governments formulated their own lockdown policy.

First lockdown experience could have served useful lessons for economic actors to plan their activities during the second.

Also, low base effect of Q1 FY22 showed a quick turnaround.

However, the epidemic’s severity might have led to a higher private expenditure on health.

The sudden increase in net financial assets in the first quarter (June 2020) must be a result of lockdowns (Chart 1). This trend defied cyclicality — the fourth quarter typically shows a temporary peak in net financial asset flow (higher share of income channelled into savings).

Understandably, households saved more during the lockdowns, curtailing discretionary spending. By the second quarter, the net financial position came back to March 2020 levels — which is also against the cyclicality observed in the last two years. This trend of decreasing net financial assets continued until the third quarter of FY21.

In Q2 FY21, net financial assets decreased rapidly, by 10.6 per cent of GDP: an increase in financial liabilities of 7.4 per cent of GDP combined with a 3.2 per cent decrease in financial assets — implying households started borrowing more and saving less. From Q2 to Q3, assets further declined by 3.1 per cent (of GDP), while the amount of liabilities accumulated, declined by 0.8 per cent of GDP. These are flow numbers — the percentage of GDP channelled into savings/liabilities in a quarter; not the total outstanding savings/liabilities with households (similar to income statement vs balance sheet for firms).

Expected liability

In Chart 2, the expected financial liability is calculated for FY21 (three quarters) by averaging out the respective numbers of the last two financial years (Chart 2). For FY19 and FY20, expected and actual are the same, of course. Relatively elevated levels of liability is observed in the second and third quarters. Part of it could be postponed purchases of cars and homes, while part of it could be personal loans and credit cards, in order to pay recurring bills. If debt is required to pay off household bills, the ability to consume will remain restrained.

From June 2018 to December 2020, India’s overall household debt-to-GDP ratio has consistently grown from 31.4 per cent to 37.9 per cent (note that this is a stock metric — like a balance sheet number). The increase happened even during the pandemic year — driven by low GDP. To put this into perspective, we take household debt-to-GDP ratios of other countries just before the pandemic (December 2019 data; Table 1).

India’s current household debt level (37.9 per cent of GDP) isn’t unsustainable; even in the context of pre-pandemic levels of other major economies (Indonesia had a particularly low household debt). Additionally, the low-interest rate regime maintained by the RBI could make household debt positions less burdensome.

Hence, encouraging banks to lend to consumers while maintaining adequate credit quality standards would be an important step to revive consumption. Consumption thrives on credit, as shown in Chart 3, where consumption rebound in Q2 and Q3 of FY21 is accompanied by a rebound in borrowings of households .

Gross financial borrowing in Chart 3 is the flow of financial liabilities that households accrued in the given period (borrowings from financial corporations). In Q3 FY21, this figure was ₹2.48-lakh crore representing 4.6 per cent of quarterly GDP. Over the 2018-20 period, the annual flow of financial liabilities has varied between 2 per cent and 6 per cent of quarterly GDP. As seen above, the stock of financial liabilities with households stands at 37.9 per cent of GDP, as of December 2020 — a majority of them with the banking sector. The stock of financial liabilities has been in excess of 30 per cent since 2018.

Using the stock and flow metrics, approximate loan repayment burden as a percentage of GDP can be computed — in calendar year 2020, this figure stood at an average of 1.98 per cent of quarterly GDP in contrast with 3.81 per cent in calendar 2019. While the moratorium policies of the RBI no doubt had a role to play, the sustainability of household debt levels also depend on the repayment burden as a percentage of GDP — an additional and useful indicator of the financial health of the households.

Tejkiran is an MBA student, and Das is Professor of Economics IIM Ahmedabad

COMMENT NOW