India’s Looming Financial Crisis

The rapid credit growth in India has raised concerns about a potential financial crisis. The situation is exacerbated by an unregulated financial sector, unsustainable household debt, and a dangerous narrative of economic prosperity fueled by credit expansion.

A Lofty and Dangerous Narrative:

• Unhinged Hype: India is experiencing a credit boom driven by policymakers promoting the narrative of financial innovation and inclusion through digital infrastructure. This hype has led to a poorly regulated financial sector and increased consumer debt.
• Applauding Credit Surge: Both international and domestic analysts have praised India's financial sector growth, citing robust bank lending and low non-performing assets. For instance, the IMF and NCAER highlighted a 20% increase in bank lending in recent reviews.
• Debt-Fueled Prosperity: The surge in lending, particularly for personal loans, masks deeper issues such as job deficits and human capital deficiencies. When lending slows, the financial sector's apparent health is at risk, potentially leading to an economic crunch.

Household Debt and Economic Risks:

• Household Debt Boom: The expansion of household lending, growing at 25-30% annually, is considered a "bad" boom. It drives up domestic prices without enhancing productive capacity, making the economy less competitive.
• Unsecured Loans: A significant portion of household loans, about a quarter, is unsecured, with credit card debt being a major component. The number of credit cards in India rose from 20 million in 2011 to nearly 100 million in 2024, often extended to low-creditworthy individuals.
• Debt-Service Burden: Despite household debt being 40% of GDP, the debt-service-to-income ratio is 12%, one of the highest globally. This situation mirrors the pre-crisis conditions in the US and Spain before the 2008 financial crisis.

Challenges of Regulation and Preventive Measures:

• Chaotic Financial Services Industry: The financial sector in India is characterized by a large number of providers, including banks, NBFCs, and fintech companies, many with dubious practices. The pressure to generate profits has led to increased lending to households rather than productive sectors.
• Scams and Misuse: Since economic liberalization in 1991, financial scams have proliferated. Post-COVID-19, fintechs and NBFCs have targeted households with high-interest loans, leading to a cycle of debt and addiction to credit.
• Preventive Measures: To avert the crisis, the financial services industry needs to be downsized to align with productive borrowing needs. Policy changes should include weakening the rupee to boost exports and mitigate the downturn.

UPSC Mains Questions:

Q. Examine the impact of rapid credit growth on the financial stability of an economy. Discuss the potential risks associated with unregulated expansion of household debt