The risks associated with this rapid credit expansion

Source: The post the risks associated with this rapid credit expansion has been created, based on the article “India’s looming financial crisis” published in “The Hindu” on 12th June 2024

UPSC Syllabus Topic: GS Paper 3– economy-mobilisation of resources, growth, development and employment

Context: The article discusses how rapid growth in lending in India is leading to financial instability. It warns that excessive borrowing, particularly by households, is creating a risky economic situation that could lead to a financial crisis similar to those experienced in other countries. The risks associated with this rapid credit expansion

For detailed information on Issues with credit system in India read this article here

What is the current state of credit growth in India?

1. India is experiencing rapid credit growth, particularly in the household sector, which is rising at an annual rate of 25% to 30%.
2. In 2023, the International Monetary Fund (IMF) praised India’s financial sector for robust bank lending and low non-performing assets.
3. A review by the National Council of Applied Economic Research in March 2024 noted a 20% increase in bank lending from the previous year, with a significant rise in personal loans.
4. The surge in lending is primarily directed towards consumer spending rather than productive investments, contributing to economic vulnerabilities.

What are the risks associated with this rapid credit expansion?

1. Financial Instability: Rapid credit growth historically leads to financial crises. Previous booms ended when new loans couldn’t cover old debts.
2. Unsecured Borrowing: Almost a quarter of household loans are unsecured, increasing financial system stress. Credit card debt surged from 20 million cards in 2011 to 100 million in 2024.
3. Economic Contraction: High debt burdens reduce household spending, leading to economic slowdown. Indian households’ debt-service-to-income ratio is 12%, one of the highest globally.
4. Inefficient Lending: Financial institutions focus on consumer loans instead of productive investments. This can lead to economic downturns when consumer spending slows.
5. Job Shortage: The ongoing job crisis will worsen, pushing more people back to agriculture, reflecting deeper economic regression and increasing inequality.

What should be done?

1.Improve financial regulation: Strengthening oversight is necessary to prevent rogue behavior among financial institutions. The rise in unsecured loans, approaching a quarter of household loans, indicates a poorly regulated financial sector. Fintech companies have led the charge in offering high-interest loans to households, contributing to financial stress.

2. Weaken the rupee: A weaker exchange rate can boost exports, helping to cushion the economic downturn. Historical data shows that rapid credit growth and an overvalued exchange rate are a lethal combination.
3. Focus on job creation: Address the deep-rooted jobs deficit to ensure sustainable economic growth. Current policies have led to more workers returning to agriculture, highlighting the urgent need for job-rich growth.

Question for practice:

Examine the current state of credit growth in India and the associated risks with it.