Indians borrow because they have volatile incomes and this creates debt traps
Since many Indians don’t earn regularly, they end up borrowing expensively.
While most Indians might suffer from income volatility, their consumption expenditure is more regular, suggesting that there is already nascent consumption smoothing. However, much of this consumption is driven by debt. In fact, the two main features of Indian household debt are that Indians are becoming more over-indebted and that inefficient, informal sources of borrowing crowd out lower-cost, secured institutional debt.
Indian households are sinking increasingly deeper in debt. As a percentage of GDP, household debt has increased from 11.2% to 37.1% — more than tripling — between 2011 and 2021. Mortgages and gold loans, which are used to finance Indians’ two preferred assets, only account for 23% and 8% of household debt, respectively. Greater consumption of services such as education and healthcare, which have become more expensive, could also account for rising debt. Notably, though, for Risers and Aspirers, much of the rest of their debt arises from discretionary consumption expenditure. The widespread availability of, and increasing demand for, no-cost EMIs on durable goods, credit cards, and personal loans can be seen from the 13% growth in consumer loan products in the third quarter of 2019. For low-income households (Strivers), credit might be treated as an additional income source. In 2016–17, 53% of agricultural households had an outstanding loan debt averaging INR 104,600, or about 98% of their mean annual income.
Household debt, itself, is not necessarily a negative feature. On the contrary, the efficient use of debt could afford great benefits to individuals, and, by extension, to society as a whole. One of the most significant issues with Indian household debt, however, is the extent to which it comes from expensive, non-institutional sources. Unsecured debt from moneylenders, corner shops and family and friends comprises 56% of Indian households’ liabilities. Unsecured debt carries exorbitant interest rates because there is no collateral, exacerbating the already high cost of capital in India. The median annual interest rate for non-institutional loans (both secured and unsecured) is around 25%, and the maximum could reach 60%. Both the extremely high rates and the large spread between the median and maximum illustrate the potential for exploitation and debt traps. In sharp contrast, secured, institutional loans charge interest rates of 12% and 16%, as a median and maximum respectively. While even these interest rates are high, relative to those in developed countries, the amount that borrowers could save by replacing unsecured, non-institutional debt with credit from more formal, asset-backed sources is clearly evident.
There is evidence that institutional credit already has some traction among sizable demographics, such as rural Strivers. For example, agricultural households, which are richer than their non-agricultural, rural counterparts, currently draw 46% of their debt from commercial banks, illustrating that this is an existing trend that can form the foundation of further growth.
