In this article on household finances, we have looked into various aspects of household debt. Household debt in India was 48 per cent of personal disposable income (PDI) in FY23, much lower than 80-100 per cent in the Western world, and as much as 100 per cent in China. As percentage of GDP, it was over 38 per cent in India, compared to 73 per cent in the US, 80 per cent in the UK, more than 100 per cent in Australia and 62 per cent in China. Is India’s household debt high or low? What is the threshold level of household debt in India, beyond which it would turn unsustainable?
One of the most common and reliable ways to answer this question is to estimate debt service ratio (DSR) for Indian households, compare it with its counterparts in other nations and with its own past trends. DSR measures the proportion of income dedicated to meet loan-related obligations (principal and interest). So, a DSR of 10 per cent would mean that, on an average, a typical household spends 10 per cent of its income to meet its loan repayment dues. A higher DSR means higher debt repayment obligations, which tend to affect GDP growth adversely via the restricted ability of a household to grow its spending.
Two key components
An estimation of DSR has two major components — residual maturity and effective interest rate. The lower the residual maturity and the higher the effective interest rate, the higher (and worse) the DSR will be and vice-versa. According to the Financial Stability Report of the Reserve Bank of India published in December 2023, DSR of Indian households is 6-7 per cent, which is not only comparable to other economies, but also very stable in the past few years.
According to the RBI, the weighted average effective interest rate stood at 9.7 per cent in FY23 and the residual maturity of retail loans (from a survey of 12 major scheduled commercial banks, comprising about 80 per cent of the retail loan portfolio at the system level) was 12.7 years on the existing stock of debt. One, thus, does not need to worry excessively about the rising household debt in India, as DSR is contained.
This, however, is in stark contrast to our calculations of household DSR in India, which was published in a report titled ‘How sustainable is India’s household debt?’ on October 4, 2023. According to our analysis, DSR for Indian households is 11-12 per cent (almost double of that estimated by the RBI), which is not only much higher compared to its counterparts in other major economies, but has also increased in the past years. The substantial difference between our and the RBI’s estimates of household DSR emerges from the residual maturity (effective interest rates are similar). In stark contrast to the RBI’s residual maturity of 12.7 years, our calculations suggested a residual maturity of only about 5.5 years. What explains this difference and what are its implications?
There are four parts in India’s household debt — housing loans (including priority sector lending), non-housing personal loans, agricultural loans and business loans. Of these four parts, housing loans, by far, would be the longest maturity loans. Of the total household debt totalling ₹102 trillion in FY23, housing loans were ₹29 trillion (banks and housing finance companies). It means housing loans account for less than 30 per cent of household total debt in India, which, when compared with other major economies, is among the lowest share. Even if one assumes a residual (not contracted) maturity of 12 years on the housing loan portfolio, the remaining household debt must have a residual maturity of around 13 years to make RBI’s estimates credible. This looks impossible.
Agricultural loans, which account for about 15 per cent of household debt in India, are primarily short-term crop loans, with a maturity about one year. Similarly, business loans, which account for another 24-25 per cent of household debt in India, are also likely to be dominated by working capital loans (of 1-3 years), rather than long-term investment loans (which we expect to be a part of corporate loans).
Of the remaining non-housing personal loans, vehicle loans (including that of banks and non-banking finance companies, NBFCs) account for 9 per cent of household debt and education loans were less than 1 per cent of household debt. These loans are likely to have a residual maturity of 3-5 years, with the remaining non-housing personal loans (which include all unsecured and gold loans) falling into 1-3 years’ maturity profile.
In short, this understanding suggests that around 30 per cent of household debt may have a residual maturity of 12 years, another 10-15 per cent is likely to have a residual maturity of say, 5 years, and the remaining 55-60 per cent may have a residual maturity of, say 2 years (i.e., 1-3 years). If so, the weighted average residual maturity of the entire household debt would be less than 5.5 years.
In fact, according to the RBI, only 22.5 per cent of banks’ entire loan book (at ₹143 trillion in FY23) had a maturity of above 5 years in FY23, compared to 16-17 per cent a decade ago. With an effective interest rate of 9.7 years and weighted average residual maturity of 5.5 years, Indian household DSR would be around 12 per cent, instead of 6-7 per cent estimated by the RBI. Is this high or low?
Reverse calculation
This can be gauged by comparing a 11-12 per cent DSR for Indian households at <50 per cent leverage ratio (debt-to-PDI), with 6-9 per cent household DSR in several advanced economies with much higher (almost double) leverage ratio. Household DSR in China with debt-to-income ratio of >100 per cent is estimated at 8.8 per cent. A few advanced economies, which have a household DSR of more than 10 per cent, have household debt at more than 175 per cent of income.
Doing reverse calculations, if we assume that DSR should not exceed 15 per cent, residual maturity increases to 6 years and effective interest rate reduces to 9 per cent over the next years, then the threshold level of household debt in India would be 67 per cent of PDI. At the current rate of the growth in household debt and PDI, this threshold level will be reached by the end of this decade, i.e., around FY30. This is, thus, not an immediate concern, but presents a potential threat, if it continues to grow at the same pace.
Overall, as we conclude this four-part series, households’ financial position has weakened in India. And even though the headline debt-to-income ratio is low in India, it is not without its share of concerning trends.
The writer is Senior Group Vice-President - Institutional Research - Economist, Motilal Oswal Financial Services Ltd. He is the author of The Eight Per Cent Solution