India has experienced a great wave of corporate deleveraging for most of this decade. Have households also started to deleverage? New data shows household debt fell by nearly ??1.5 trillion in the 12 months to March 2020.
The Reserve Bank of India (RBI) had released preliminary estimates of Indian household financial assets and liabilities earlier this month, which include unincorporated businesses in our statistical framework. The data covers three years up to fiscal 2020 which ended in March. A comparison with similar data over a longer period is revealing.
Indian household borrowing – or the difference between gross financial savings and net financial savings – averaged 2.9% of gross domestic product (GDP) over the six fiscal years between 2011-12 and 2016 -17. Household debt increased sharply during the 2017-18 financial year, to 4.3% of GDP. This fell slightly to 3.9% in 2018-19, then sharply to 2.9% in 2019-2020.
In other words, household indebtedness during the fiscal year ended in March returned to the average level observed at the start of the decade. Another interesting angle is the household finance figures for the previous year. Household gross financial assets actually declined by 50 basis points in 2019-2020, from 11.1% of GDP to 10.6%. However, household net financial assets increased by 50 basis points despite the decline in gross financial assets, from 7.2% of GDP to 7.7%. This is explained by the drop of one percentage point in household debt as a percentage of GDP.
Why is this happening? A previous installment of this column had covered similar territory. Three points bear repeating in the context of the new data on household finances.
First, economists generally believe that how people react to an economic shock, like the one the world is currently facing, depends a lot on whether they view it as temporary or permanent. The basic rule to remember is that economic agents will try to smooth consumption by borrowing in case they think the shock is temporary. And they will smooth savings by reducing consumption in case they interpret the shock as permanent.
Second, a simple way to understand why households hold financial assets, including cash, is to use them for trading, precautionary or speculative purposes. Precautionary savings tend to increase when people are faced with income uncertainty. Bank data already shows that people are holding more money than before and prefer to park their financial savings on time rather than demand deposits. On the other hand, data from the RBI on household financial savings shows that borrowing from banks increased in the fourth quarter of 2019-2020, partly due to seasonal factors but also possibly due to the distress. economic due to covid-19.
Third, a shift in household financial decisions, both in terms of higher precautionary savings and reduced borrowing, will have broader economic implications that policymakers need to pay attention to. As HSBC Indian chief economist Pranjul Bhandari argued in these pages on Tuesday, higher savings will reduce the chances of a consumer spending-led recovery on the one hand, but on the other hand, it will also help finance higher budgetary outlays. In other words, the risk aversion of Indian households could mean an increased demand for safe assets such as government bonds, which are bought directly or indirectly through bank deposits, insurance policies, funds. provident funds and mutual funds. However, it is also important to remember that a reduction in the current account deficit will erode some of the benefits of higher household financial savings in terms of financing the budget 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 businesses. Companies have used their free cash flow to pay off their debts. The gross savings of non-financial corporations in the private sector increased as a percentage of GDP. Banks have turned to providing consumer credit in response to the lack of demand for credit from businesses. Recent trends in household indebtedness, as well as the anticipated rise in precautionary savings in response to the covid-19 shock, could also cause consumer loan growth to dry up.
These trends have implications for both India’s fiscal and monetary authorities. And their response will be particularly important when the economy stabilizes, as the two main drivers of aggregate domestic demand are likely to be weak due to risk aversion: private sector capital investment 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 Council of the Meghnad Desai Academy of Economics
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