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Home / Opinion / Columns /  Opinion | Debt is now an unwanted burden across most of India’s economy

India has seen a great wave of corporate de-leveraging through most of this decade. Have households begun to deleverage as well? New data shows that household debt has come down by nearly 1.5 trillion in the 12 months to March 2020.

The Reserve Bank of India (RBI) had earlier this month released some provisional estimates of the financial assets and liabilities of Indian households, which includes unincorporated enterprises in our statistical framework. The data is for three years till fiscal year 2020 that ended in March. A comparison with similar data over a longer period of time is telling.

Borrowings by Indian households—or the difference between gross financial savings and net financial savings—averaged 2.9% of gross domestic product (GDP) in the six fiscal years between 2011-12 to 2016-17. There was a sharp increase in household leverage in fiscal year 2017-18, to 4.3% of GDP. That fell a bit to 3.9% in 2018-19 and then sharply to 2.9% in 2019-20.

In other words, household leverage in the fiscal year that ended in March has come back to the average level seen in the earlier part of the decade. The household finance numbers for the previous year have another interesting angle. The gross financial assets of households actually fell by 50 basis points in 2019-20—from 11.1% of GDP to 10.6%. However, net financial assets of households increased by 50 basis points despite the drop in gross financial assets—from 7.2% of GDP to 7.7%. This is explained by the one-percentage-point drop in household debt as a percentage of GDP.

Why is this happening? A previous instalment of this column had covered similar territory. Three points are worth repeating in the context of the new data on household finances.

First, economists generally believe that the way people react to an economic shock, such as the one the world is currently facing, depends a lot on whether they see it as a temporary one or a permanent one. The thumb rule to remember is that economic agents will try to smoothen consumption by borrowing in case they think the shock is temporary. And they will smoothen savings by cutting consumption in case they interpret the shock as permanent.

Second, one simple way to understand why households hold financial assets, including cash, is by purpose—for transactions, precaution or speculation. Precautionary savings tend to increase when people face income uncertainty. There are already signs from banking data that people are holding more cash than before as well as preferring to park their financial savings in time rather than demand deposits. On the other hand, RBI data on financial savings of households shows that borrowings from banks did spike in the fourth quarter of 2019-20, partly because of seasonal factors but also perhaps because of economic distress from covid-19.

Third, a change in the financial decisions of households—both in terms of higher precautionary savings as well as lower borrowings—will have broader economic implications that policymakers need to pay attention to. As HSBC’s chief India economist Pranjul Bhandari argued in these pages on Tuesday, higher savings will on one hand reduce the chances of a recovery led by consumer spending, but on the other, it will also help fund higher fiscal spending. In other words, risk aversion by Indian households could mean greater demand for safe assets such as government bonds, which are bought either directly or indirectly through bank deposits, insurance policies, provident funds and mutual funds. However, it is also important to remember that a shrinking current account deficit will eat into some of the benefits of higher household financial savings in terms of funding the fiscal deficit.

The flip side of corporate deleveraging over the past five or six years has been a collapse in the growth of bank credit to companies. Companies have used their free cash flow to pay back debt. The gross savings of non-financial enterprises in the private sector have increased as a percentage of GDP. Banks switched to providing consumer loans in response to the lack of demand for credit from companies. The recent trends in household leverage—as well as the anticipated rise in precautionary savings in response to the covid-19 shock—could see consumer loan growth drying up as well.

These trends have implications for both India’s fiscal as well as monetary authorities. And their response will be especially important when the economy stabilizes, because it is quite likely that the two main drivers of domestic aggregate demand will be weak because of risk aversion—capital investment by the private sector and consumer spending by households. A combination of corporate and household deleveraging will pose profound challenges to our economy in the post-covid recovery phase.

Niranjan Rajadhyaksha is a member of the academic board of the Meghnad Desai Academy of Economics

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