Opinion The household debt challenge

Regulators and lenders must work together, and quickly, to distribute the impact of the surge over time

RBI household debt, Reserve Bank of India, GDP, good s and service tax, GDP growth, idian express news

According to the RBI, household debt surged to 5.8 per cent of the GDP in FY23, marking the second-highest annual increase since Independence.

Nikhil Gupta

October 31, 2023 09:34 AM IST First published on: Oct 31, 2023 at 07:58 AM IST

According to the RBI, household debt surged to 5.8 per cent of the GDP in FY23, marking the second-highest annual increase since Independence (the highest growth was at 6.7 per cent of GDP in FY07). Despite intense debate over the drivers of this surge, there is no discussion about the sustainability of such a rise in household debt. Of course, the massive growth in just one year is unlikely to lead to serious problems. The questions, therefore, are “how long can it sustain?” and “what is the threshold of household debt in India?”

One of the most widely used approaches to assess the sustainability of debt is examining the debt service ratio (DSR) of borrowers. DSR measures the proportion of the income used to repay the debt-related obligations. It is calculated as the ratio of interest payments and amortisations to income. A lower DSR indicates better sustainability and a more manageable level of household debt. The Bank of International Settlements (BIS) publishes quarterly data on household DSR for 17 advanced economies, but not on any developing country.

We need three variables to estimate

DSR — debt-to-income ratio, residual maturity/tenure, and effective interest rate. The banking system accounts for more than four-fifths of household debt in India, while housing finance companies (HFCs) and other non-banking finance companies (NBFCs) account for approximately 10 per cent each. India’s household DSR can be estimated by using the RBI data on interest rates of banks’ loan portfolios and maturity profiles (and some assumptions for NBFCs/HFCs).

India’s household debt-to-income ratio jumped to 48.1 per cent (assuming 15 per cent income growth) in FY23 from 42.2 per cent in FY19. With an effective interest rate of 10 per cent and a residual maturity of 5.3 years in FY23, the estimates suggest that the DSR of Indian households was approximately 12 per cent in FY23.

India’s household DSR has been consistently increasing over the past two decades and is higher than that of most advanced economies. The DSR of Indian households was about 12 per cent over the past three years as compared to 11.4-11.5 per cent in FY19/ FY20 and about 10 per cent a decade ago.

It is clear that a combination of higher interest rates and shorter debt tenure makes the DSR for Indian households notably higher, even if their debt-to-income ratio is less than 50 per cent. However, there is a positive aspect for India as household borrowing terms have improved over the past decade, with longer maturity periods (from 4.6-4.7 years a decade ago) and falling interest rates (from 12 per cent in FY13 and FY14).

Moreover, Indian household DSR is similar to that of the heavily indebted Nordic countries (where household debt-to-income ratio is three-four times that of India’s) and more than that in China (8.5 per cent), France (6.4 per cent), the UK (8.6 per cent), and the US (7.7 per cent) — all of which have household leverage of more than 100 per cent. The long-term median of household DSR in the 17 advanced economies for which the BIS provides data was 9.2 per cent, and the median DSR for 12 individual nations (out of 17) was less than 12 per cent. In fact, the maximum DSR witnessed in nine of these rich countries has never crossed 12 per cent in any quarter since 1999 (it was 11.6 per cent in the US in 2007).

Only a handful of nations, such as Australia, Canada, Denmark, the Netherlands, and Norway have a median household DSR above 12.5 per cent, with the highest median DSR of 17.3 per cent in Denmark (having a debt-to-income ratio of more than 180 per cent).

Using this information, one wonders if the DSR in India is already too high. Although 12 per cent DSR is high, we do not believe that Indian households have reached the threshold level. Doing a reverse calculation, and assuming 15 per cent as the threshold for household DSR, at the current interest rate and maturity, India’s household debt-to-income ratio would be approximately 60 per cent.

Without any change in the effective interest rate and maturity profile, the sustainable level of India’s household debt is about 60 per cent as compared to 48 per cent in FY23. At the current pace of growth in debt and income, Indian households would reach the threshold level over the next five to six years, that is, before the end of the decade.

One of the most effective ways to reduce the debt burden on Indian households and raise the threshold debt level is to increase the residual maturity profile of borrowers. An increase in the maturity by six months can push the threshold of household leverage by more than 4 percentage points of income. At the same time, a reduction in the effective interest rate by 1 pp raises the sustainable level of household debt by just 1.6 pp of income.

Therefore, the sustainable level of household debt-to-income ratio will reach 65 per cent, assuming 9 per cent interest rate and residual maturity of 5.8 years.

In India, household debt is increasing rapidly, with non-housing loans becoming more significant. That the RBI is drawing attention to this matter and cautioning lenders is a positive development. If this high growth continues for another two-three years, India may face a situation that will necessitate immediate action, hindering growth suddenly. Therefore, it would be preferable for regulators and lenders to collaborate as soon as possible to distribute the impact of growth over time. However, implementing this may be more challenging than simply stating it.

The writer is Senior Group Vice President, Institutional Research, Economist at Motilal Oswal Financial Services Ltd