It is always recommended to avoid credit for consumption or for the purchase of depreciable luxury items. Taking out a loan is beneficial when it improves income-generating ability – like a loan to improve production capacity, or an education loan to improve employability, or to acquire substantial fixed assets that require large investments – like a home loan that also offers opportunity to move into their own house and save on rent payments.
Lack of regular income
However, without a fixed monthly income, many Indians find no other option than to borrow money as consumer spending remains more or less the same even during the months with no or very low income.
“Since many Indians do not earn on a regular basis, they end up taking expensive loans,” said Mool CEO Abhinav Nayar, adding, “While most Indians may suffer from fluctuations in income, their spending on consumption is more regular, suggesting that this consumption smoothing is already emerging. However, much of this consumption is debt-driven. In fact, the two key features of Indian household debt are that Indians are becoming increasingly over-indebted and that inefficient, informal sources of credit are crowding out lower-cost, secured institutional debt.”
High debt
With very little opportunity for higher income to repay the loan along with high interest rates, the debt burden continues to mount.
“Indian households are becoming increasingly indebted. As a percentage of GDP, household debt increased from 11.2 percent to 37.1 percent between 2011 and 2021 — more than tripling. Mortgages and gold loans, used to finance Indians’ two favorite assets, account for just 23 percent and 8 percent of household debt, respectively. The increased consumption of services such as education and health care, which have become more expensive, could also be responsible for the rising debt. Notably, however, among climbers and aspirers, much of the remaining debt comes from discretionary consumer spending. The widespread availability and increasing demand for free EMIs for durable goods, credit cards and personal loans is reflected in the 13 percent growth in consumer credit products in the third quarter of 2019. For low-income households (geeks), loans could be treated as an additional source of income. In 2016-17, 53 percent of farming households had an outstanding loan debt averaging Rs. 1,04,600, or about 98 percent of their median annual income,” Nayar said.
High interest rate
In order to get loans on favorable terms, one must have a stable income and a good credit rating. However, due to volatile incomes and poor repayment history, such borrowers do not have access to cheaper institutional credit and have to rely on high-interest loans from moneylenders.
“Household debt in itself is not necessarily a negative trait. On the contrary, the efficient use of debt could bring great benefits to the individual, and therefore to society as a whole. However, one of the key problems with Indian household debt is the extent to which it comes from expensive, non-institutional sources. Unsecured debt from moneylenders, corner shops and family and friends accounts for 56 percent of Indian household liabilities. Unsecured debt carries exorbitant interest rates due to the lack of collateral, compounding India’s already high cost of capital. The average annual interest rate for non-institutional loans (both secured and unsecured) is around 25 percent, and the maximum rate could reach 60 percent. Both the extremely high interest rates and the wide range between median and maximum illustrate the potential for exploitation and debt traps. In sharp contrast, secured institutional loans charge median and maximum interest rates of 12 percent and 16 percent, respectively. Although even these interest rates are high compared to those in developed countries, the amount that borrowers could save by replacing unsecured, non-institutional debt with loans from more formal, asset-backed sources is clear,” Nayar said.
Institutional Credit
While poor and needy people have little or no access to cheaper institutional credit, wealthier rural households borrow heavily from financial institutions.
“There is evidence that institutional lending already has some appeal among sizeable populations like Strivers in the countryside. For example, agricultural households, who are wealthier than their non-agricultural rural counterparts, currently borrow 46 percent of their debt from commercial banks, showing this is an ongoing trend that may lay the foundation for further growth,” Nayar said.
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