The problem with household debt


Source: By Tulsi Jayakumar: Mint


What should be the monetary policy stance in an economy which has suffered the demonetisation exercise? The Reserve Bank of India, in its sixth bi-monthly monetary policy, three months after demonetisation, kept the policy repo rate unchanged while announcing a change in its policy stance from accommodative to neutral. Traditional debate and analysis has centred around the efficacy of rate cuts in stimulating investment and growth. A deeper question, which has drawn scant attention however, is the issue of growing household debts and the consumption-led growth which such interest-rate cuts have the potential to facilitate.

A recent paper analyses the macroeconomic implications of household debt in the short and long run by analysing quarterly household data for 54 economies for the period 1990-2015. The authors find that debt boosts consumption and GDP (gross domestic product) growth in the short run, i.e. a one-year period. But in the long run, household debts have a negative effect on growth, with a 1% increase in the household debt-to-GDP ratio lowering output growth in the long run by 0.1%. The authors suggest that policymakers face “non-trivial, real costs” in stimulating the economy through credit expansion.

The authors further find that as the household debt-to-GDP ratio exceeds a threshold of 60%, the negative long-run impact of household debt on consumption intensifies. The estimated threshold effect for GDP growth is larger, with the negative debt effect intensifying as the household debt-to-GDP ratio exceeds 80%.

Country-specific institutional factors, particularly the degree of legal protection to creditors, affect the sustainability of such household debt. Further, while financial development in emerging market economies (EMEs) has a positive impact on the relationship between higher household indebtedness and growth in the short run, the degree of financial development plays little role in reducing the negative impact of higher household debt on growth in the long run.

The National Sample Survey Office (NSSO) Survey 70th round, the results of which were published in November 2016, studies household indebtedness for the period January-December 2013 in India. A perusal of the data shows that about 31.4% of Indian rural households and 22.4% of urban households are in debt. The incidence of indebtedness grew much faster in rural India than in urban India, with 35% of cultivator households being indebted in rural areas in 2012, as against 25.9% in 1991. Again, one in about five households in urban areas at the national level was indebted households. Regionally, the indebtedness was far greater in the southern states of Andhra Pradesh, Kerala, Telangana and Karnataka, with the incidence being above 40-50%.

More important is the declining role of cheaper institutional credit in the total cash debt in rural segments, vis-à-vis the exploitative traditional sources of non-institutional credit such as agricultural moneylenders, landlords, traders, etc. The share of institutional credit in the outstanding cash dues of rural households decreased steadily from 61% in 1981 to 56% in 2012. In contrast, the institutional share in urban indebtedness increased and was about 85% in 2012.

More than 40% of rural loans were on compound interest terms. However, even the “simple interest loans” were not really low-interest/interest-free. Non-institutional loans to rural households were at rates as high as 20%. Further, 69% of the total rural household loans and 58% of urban household loans comprised such high-interest loans from non-institutional agencies. Moreover, both rural and urban households seemed to be borrowing less for productive purposes, with the percentage of productive loans coming down from 69% to 40% for rural, and from 42% to 18% for urban, households over the period 1981-2012.

It is clear that institutional credit availability to facilitate rural consumption and growth has been on the wane, with larger household debts being incurred through non-institutional sources, borrowed at very high rates of interest for unproductive purposes. While international studies point to the negative long-run impact of household debt on consumption and growth, such debt-driven consumption as prevalent in India is likely to be even more unsustainable, and non-growth-inducing.

Monetary policy will need to pay attention to this link between consumption and growth. The success of monetary policy and the transmission mechanism would be predicated on the successful reach of institutional credit agencies in rural areas and their growing share in rural household debt.

A perusal of the Global Competitiveness Report further reflects the challenges posed by institutional factors such as “efficiency of the legal framework in resolving disputes”. India will need to strengthen its dispute-resolution mechanism, as also its legal-rights index. The presence of the right institutional environment will have a bearing on the sustainability of household debt.

While the Economic Survey and the budget document have raised concerns about corporate debt and government debt, growing household debt may be the blind spot. Economic analysts, as also the monetary authorities, may need to go beyond their traditional obsession with the growth-inflation outcomes of monetary policy to the underlying conundrums of such growth itself.


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Dr Khan

Dr. Khan began his career of teaching in 1988 as lecturer in a college of University of Delhi. He later taught at Delhi School of Economics, University of Delhi. He has several research papers and books to his credit.
Dr. Khan has been teaching General Studies since February 1992 to IAS aspirants and is very proud of the fact that almost every State and Union Territory in India has some civil servants who personally associate with him.

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