India’s Looming Financial Crisis

India’s Looming Financial Crisis

Sub: Economy

Sec: National Income

Rapid Credit Growth and Its Consequences

• Rapid credit growth is akin to a siren song, promising prosperity but often leading to financial crises.
• The narrative of “this time is different” is driven by India’s digital infrastructure hype, promoting financial innovation and inclusion, but also leading to a poorly regulated financial sector and consumers living beyond their means.

Applauding the Surge

• In December 2023, the IMF Board of Directors praised the performance of India’s financial sector, noting robust growth in bank lending and low levels of non-performing assets.
• The National Council of Applied Economic Research in March 2024 highlighted a 20% increase in bank lending over the previous year, with a significant increase in personal loans while lending to industry lagged.

The House of Cards

• The financial sector appears healthy as long as new loans can pay off old ones. The IMF knows this well: when lending slows, households and businesses reduce spending to repay debt, causing an economic crunch.

Household Debt Boom

• Financial intermediaries have expanded household lending at between 25% and 30% a year.
• Unsecured household loans make up almost a quarter of total household loans.
• As of January 2024, Indians owned almost 100 million credit cards, up from 20 million in 2011.
• Indian household debt is 40% of GDP, which is low by international standards
• The household debt-service-to-income ratio is 12%, is among the highest in the world because of high interest rates and predominantly short duration loans. Indeed, the Indian household debt-service ratio is alarmingly similar to that in the United States and Spain just before their 2008 financial crises, when high household debt-service burdens precipitated major economic downturns

Financial Services Industry

• India’s financial services industry is large and chaotic, with 30-odd large providers and thousands of smaller players, including fly-by-night NBFCs and fintechs.
• After COVID-19, lending shifted towards households, with fintechs offering loans at high-interest rates.

The Looming Crisis

• Despite buoyant credit growth, household consumption is increasing slowly.
• Defaults on loans will lead to more defaults due to the interconnected nature of banks, NBFCs, and fintechs, causing a cascading economic contraction.

Preventing the Crisis

• Preventing the crisis requires downsizing the financial services industry to match lending capacity with productive borrowing needs.
• Weakening the rupee is necessary to expand exports and cushion the downturn when it comes.
• Indian policymakers have committed to the notion that finance will spur growth despite the risks, and they view a strong exchange rate as a metric of national strength.

In conclusion, India’s rapid credit growth, while currently celebrated, carries significant risks that could lead to a severe financial crisis. Addressing these issues requires careful policy adjustments and a shift away from the current reliance on credit-driven growth.