The bone of contention in the recent debate has been the drastic fall in household net financial savings to GDP ratio during 2022-23 on account of a higher borrowing to GDP ratio. In response to our previous article ‘On the Fall in Household Savings’ (The Hindu, April 21, 2024), the Chief Economic Advisor (CEA) to the Government of India has interpreted this trend as a mere shift in the composition of household savings, where households are argued to incur greater borrowing (or reduce net financial savings) solely to finance higher physical savings (investment). In this article, we argue that this interpretation is inconsistent with broad trends and highlight some signs of structural shifts in the Indian economy.

Not a mere change in savings pattern

The household savings to GDP ratio is the sum of its net financial savings to GDP ratio, physical savings to GDP ratio and gold and, ornaments. A mere shift in the composition of savings would have kept the overall household savings to GDP ratio unchanged, with lower net financial savings to GDP ratio or higher borrowing to GDP ratio being fully offset by higher physical savings to GDP ratio. Figure 1 shows the extent to which these ratios changed during 2022-23 as compared to 2021-22 and indicates a contrary phenomenon.

The net financial savings to GDP ratio declined by 2.5 percentage points, whereas the physical savings to GDP ratio increased only by 0.3 percentage points. The household borrowing to GDP ratio increased by 2 percentage points, significantly more than the increase in the physical savings to GDP ratio. With the gold savings to GDP ratio remaining largely unchanged, the household savings to GDP ratio declined by 1.7 percentage points. In short, the phenomenon of a household’s higher borrowing to GDP ratio cannot be explained exclusively in terms of change in savings composition. In our last article, we argued that lower net financial savings to GDP ratio and higher borrowing to GDP ratio largely reflected a household’s need to finance greater interest payment commitments at a given income amid higher interest rates and debt-income ratio, leading to an increase in financial distress of the household.

Surprisingly, the CEA’s response is based on the analysis of absolute nominal numbers of household total savings. He argues that the nominal value of a household’s total savings has increased, as the nominal value of physical savings has increased more than the fall in nominal value of net financial savings. However, this trend merely shows that the nominal (inflation unadjusted) growth rate of total household savings has been positive during 2022-23, which has hardly been a topic of contention. A positive nominal growth rate of savings neither addresses the historic fall in net-financial savings to GDP ratio nor refutes our explanation of the higher borrowing to GDP ratio and the phenomenon of greater interest payment burden of the household that we pointed out.

The phenomenon of household’s higher interest payment burdens and debt-income ratio in the post-COVID period, however, brings forth two important questions: Does it reflect a qualitative change in the structure of the macroeconomy in the recent period? If yes, how different are these features from the previous episodes when household borrowing increased?

Signs of structural shift

Since the share of interest payment in household income (interest payment burden) is the product of interest rate and debt-income ratio, any increase in the latter would lead to a greater interest payment-income ratio at a given interest rate. The recent period has been associated with a sharp rise in both these variables. The debt-income ratio of the household can potentially change through two distinct factors. The first factor pertains to a higher net borrowing-income ratio of the household, where net borrowing is the difference between total borrowing and interest payments. Household’s stock of debt would rise at any given level of income if they decide to increase their net borrowing for financing higher investment or consumption.

The second route involves factors that are largely exogenous to the household’s decisions-namely, the interest rate on the outstanding debt and the nominal income growth rate of the household. Any increase in interest rates or reduction in nominal income growth rate increases a household’s debt-income ratio during a particular period. If the growth in interest payments outweighs income growth, the debt-income ratio will continue to grow. Such mechanisms can be described as “Fisher dynamics” following Irving Fisher, who explained the phenomenon of rising debt-income ratio in terms of changes in interest rate and nominal income growth rate.

Starting from the pre-COVID growth slowdown of 2019-20, the Indian economy has typically been characterised by such Fisher dynamics. The post-COVID period has seen a sharp rise in the ratio between nominal debt and nominal income of the household, largely on account of a lower nominal income growth rate. The debt-income ratio as an indicator of household leverage (or repayment capacity) has received scrutiny, particularly after the global financial crisis. Notwithstanding the recent rise in the lending rate that has contributed to the rise in debt-income ratio, the key structural feature that has emerged in the recent period is that the nominal income growth rate has often been lower than the weighted average lending rate. This seems to be the very mechanism by which a household’s interest payment burden and debt-income ratio have increased.

Table 1a shows that the average value of the growth rate of household disposable income has been lower than the weighted average lending rate (WALR) for the period 2019-20 to 2022-23. The average value of the lending rate for this period is constructed from the Reserve Bank of India’s quarterly figures. The household disposable income data is not yet available for 2023-24. However, the gross national income (GNI) growth rate, which is closely associated with the growth rate of household disposable income in the recent period, has recorded lower than the average WALR for this year. These emerging features seem to stand in contrast with previous episodes of high household borrowing, like the period of 2003-04 to 2007-08. While a long run comparison becomes difficult with the indicators used in Table 1a, one can use International Monetary Fund’s lending rate data and the GNI growth rate for the analysis. Table 1b shows that the average GNI growth rate was greater than the average lending rate from 2003-04 to 2007-08. In contrast, the average GNI growth rate was lower than the average lending rate during the period 2019-20 to 2021-22.

Macroeconomic challenges

The comforting news at the present juncture is that India’s debt servicing ratio is still lower than that of many countries. But with the emergence of the Fisher dynamics, there are at least two unique challenges that confront the Indian economy.

The first challenge pertains to decreasing the gap between interest rate and income growth and slowing down the growth of the debt-income ratio of the household. While the level of debt-income ratio presently remains low, frequent episodes of income growth lagging behind the lending rate can quickly push up household’s interest payment burdens.

The second challenge involves stemming the possibility of downward adjustment of aggregate demand amid high interest payment and debt commitments of the household. Such possibilities emerge when households tend to maintain stock-flow norms in debt and wealth management by curtailing their consumption expenditure. The sharp decline in the consumption to GDP ratio in 2023-24 points towards such a possibility. These challenges point towards the need to include an additional macroeconomic policy target to stimulate and support household income growth.

Zico Dasgupta and Srinivas Raghavendra teach economics at Azim Premji University

The fall in household savings has been at the heart of recent debates in India. The decline in household savings is brought about by a drastic reduction in net financial savings as the household net financial savings to GDP ratio attained a four-decade low. Figure 1 shows the broad trend in household savings, physical savings and gold, and net financial savings.

The sharp reduction in household net financial savings in 2022-23 has been associated with an overall fall in household savings despite marginal recovery in physical savings.

Interpreting lower financial savings

The net financial savings of the household is the difference between its gross financial savings and borrowing. The gross financial savings of a household is the extent to which its financial assets change during a period. The financial assets of households typically comprise bank deposits, currency and financial investments in mutual funds, pension funds, etc. Though household borrowing includes credit from non-bank financial corporations and housing corporations, the bulk of the borrowing comprises credit from commercial banks. In general, there are at least three distinct factors that can potentially bring about a reduction in household net financial savings.

First, households typically finance their additional consumption expenditure by increasing their borrowing or depleting their gross financial savings. By financing higher consumption expenditure at any given level of disposable income, lower net financial savings provide stimulus for aggregate demand and output in this case.

Also read: No small change: on the raising of returns on small savings schemes

Secondly, when households finance higher tangible (physical) investment by increasing their borrowing or depleting their gross financial savings. The reduction in net financial savings in this case stimulates aggregate demand and output through the investment channel.

Third, when interest payment of a household increases say due to higher interest rates, households can meet the increased burden through borrowing or through depleting gross financial savings thereby inducing a reduction in net financial savings.

The first factor hardly played any role in the sharp reduction in gross financial savings in 2022-23 as the consumption to GDP ratio remained largely unchanged between 2021-22 (60.95%) and 2022-23 (60.93%). The second factor played only a limited role. While the gross financial savings to GDP ratio declined by 3 percentage points (7.3% to 5.3%) in 2022-23, household physical investment to GDP ratio increased only by 0.3 percentage point (12.6% to 12.9%) during the same period. Though higher borrowing is partly financed by interest income from financial assets, it can be largely attributed to higher interest payments of the household in the recent period.

Figure 2 reflects this phenomenon by depicting the trend in household borrowing to income ratio, debt to income ratio and the ratio between household physical savings and gross financial savings.

The share of household borrowing in household (disposable) income registered a sharp spike in 2022-23. Such a rise in household liabilities was associated with a decline in the physical savings to financial savings ratio, indicating a change in household asset composition in favour of financial assets.

Implication of higher debt burden

The rise in household debt burden has two concerns for the macroeconomy.

The first concern is about debt repayment and financial fragility. Since the repayment capacity depends on the income flow, a key criterion for evaluating a household’s debt sustainability is the difference between interest rate and the income growth rate. On the flip side, the interest payments from the households are the interest income of the financial sector. If households fail to meet their debt repayment commitments, then it reduces the income of the financial sector and deteriorates their balance sheets, which in turn can have a cascading effect on the macroeconomy if the latter responds by reducing their credit disbursement to the non-financial sector.

Figure 3 shows the difference between the weighted average lending rate of scheduled commercial banks and the growth rate of gross national income.

Though the difference shows a declining trend since 2021-22, the indicator turned out to be negative in the 2023-24 period. The sharp reduction in interest rate and income growth gap is on account of lower income growth rate and higher lending rate of the commercial banks. The weighted average lending rate registered a sharp rise in the last two years, particularly due to the tight monetary policy stance of the RBI and the sharp rise in the call money rate during this period.

The second concern pertains to the implication on consumption demand. Over and above disposable income, the consumption expenditure of the household can be affected by their wealth, debt, and interest rate. Reduction in household wealth can lead to lower consumption expenditure as households may attempt to preserve their wealth position by increasing their savings.

Higher household debt can also reduce consumption expenditure in at least two ways. First, if higher household leverage is perceived as an indicator of higher default risk, then it may induce banks to indulge in credit rationing and reduce the credit disbursement. The consequent reduction in credit disbursement can adversely affect consumption. Second, higher debt can reduce consumption expenditure by increasing the interest burden, not to mention the effect of higher interest rates on consumption expenditure.

The Indian economy registered all these trends in the recent period. The financial wealth or the net worth of the household is the difference between the stock of financial assets and liabilities. As evident from figure 4, the financial wealth to GDP ratio of the household has registered a sharp decline in the recent period, along with a rise in leverage of the household as indicated by the rise in debt to net worth ratio.

Not surprisingly, the growth rate in private final consumption expenditure during 2023-24 registered a sharp decline as compared to 2022-23.

Macroeconomic implication

The implications of the procyclical leverage by the households along with the compositional change in the asset side of the balance sheet, albeit with a fall in the level of savings, for the stability of economic growth is concerning.

First, given that both the flow indicator of liabilities to disposable income and the stock indicator of debt to net worth shows an increasing trend makes the households vulnerable.

Second, the policy mantra of higher interest rate to counter inflation by reducing macroeconomic output and employment can leave households with an increasing level of debt in their balance sheets and potentially push the households into a debt trap. Third, the implications of high interest rate on debt burden can have an adverse impact on the consumption of the households and consequently for aggregate demand.

The household balance sheet trends indicate a broader change in the structure of the economy. The change in composition of the asset side of the household balance sheet towards financial assets indicate some degree of financialisation of the economy which moves from a production-based economy to a monetary or financial exchange-based economy making the five-trillion-dollar economy both jobless and fragile.

Zico Dasgupta and Srinivas Raghavendra teach economics at Azim Premji University.

For representative purposes.
| Photo Credit: Getty Images

The release of the Reserve Bank of India’s (RBI) Monthly Bulletin in September revealed that households’ net financial savings had fallen to 5.1% from 11.5% in 2020-21. Financial liabilities of households rose faster than their assets, with many writers highlighting this trend as an indication of rising indebtedness and increasing distress. The government, however, countered these claims. The Finance Ministry explained that while household financial savings may be reducing, it did not imply total savings were falling, since households took advantage of low interest rates after the pandemic to invest in assets such as vehicles, education and homes. These are two contrasting narratives, one of pessimism and distress, the other of optimism. What does data tell us about the state of the economy?

The optimistic claim

There is evidence to support the government’s narrative of a shift from financial to physical assets. Post-COVID, there has been an increase in household construction. Between 2020-21 and 2021-22, the construction sector was the fastest growing sector, growing at nearly 15% (when measured in 2011-12 prices), and 10% between 2021-22 and 2022-23. Only the trade, hotels, transport and communications sector grew faster in the latter period. Housing loans from Scheduled Commercial Banks (SCBs) grew at double-digit rates in all years between 2018-19 and 2022-23, with loans from housing finance companies growing almost 17 times between 2019-20 and 2022-23.

Liabilities in other non-financial assets have also increased. Education and vehicle loans from SCBs increased significantly between 2021-22 and 2022-23, growing at 17% and around 25% respectively. This has led to significant changes in the composition of household savings. The share of physical assets — excluding gold and silver — is almost 60% of households’ total net savings, with the share of financial savings reducing from 39.6% in 2017-18 to 38.77% in 2021-22. That is, by taking advantage of the low interest rates set by the RBI in the wake of the pandemic, households may have increased their liabilities not to fuel consumption, but to purchase non-financial assets such as houses.

The pessimistic claim

Other evidence points to a slightly different picture. The fall in household net financial savings was driven largely by a rise in liabilities. Gross financial assets declined marginally as a share of GDP between 2021-22 and 2022-23 from 11.1% to 10.9%. Gross liabilities, remaining steady at roughly 3.8% of GDP between 2019-20 and 2021-22, increased to 5.8% of GDP in 2022-23. This rise in liabilities would not imply households have reduced savings if increasing loans financed the construction and purchase of homes. However, there is evidence to the contrary. While loans for housing, education and vehicles have no doubt increased, other components of personal loans have risen even faster. The share of housing loans in total non-food personal loans from SCBs — including priority sector lending — has fallen from 51.08% in 2018-19 to 47.4% in 2022-23. The share of education loans has fallen from 3.32% to 2.37%, while vehicle loans have remained constant at around 12%.

In contrast, outstanding credit card loans increased from 3.8% to 4.7% over this period, with loans against gold jewellery rising from 1.07% to 2.16%, and the category of “Other Personal Loans” — which excludes loans for purchasing consumer durables — showing the largest rise from 24% to 27.42%. While one cannot say what these loans are being used for, these categories of loans do not necessarily indicate that they are being used solely for asset creation. Households may be taking on credit card debt and taking loans against jewellery to finance consumption. The biggest contributor to the large rise in financial liabilities between 2021-22 and 2022-23 has been loans from non-banking institutions, which grew by almost ten times in just the last year, contributing to 32.1% of the total rise in financial liabilities over this period.

The road ahead

An examination of the data reveals that even though housing loans increased, other forms of loans which might possibly be used for consumption increased even faster. But does this imply distress? It is difficult to say from just one year’s data, for we do not know if this is a trend or a one-time event. One could say that households are borrowing to maintain consumption in the face of income loss after COVID and high inflation. On the other hand, it could also be that pent-up demand during the pandemic is being realised in the form of debt-financed consumption, with households optimistic about future repayment.

However, even if the optimistic narrative is true, there are grounds for concern. The U.S. Federal Reserve’s commitment to maintaining higher interest rates to combat inflation would have a knock-on effect on interest rates around the world. Rising interest rates in India would cause significant stresses for households to meet increasing liabilities. If households have invested in real estate, rising interest rates would curtail their consumption spending and reduce aggregate demand in the economy. If, however, the narrative of distress borrowing is true, households would be subjected to further stress if interest rates rise. Policy must be observant of the myriad pitfalls facing the Indian economy.

Rahul Menon is Associate Professor, Jindal School of Government and Public Policy, O.P. Jindal Global University