Risk of debt trap? Indians buying houses to smartphones, all on loan

With rising interest rates, NBFCs are unlikely to be able to replicate their earlier growth, while borrowers are likely to be strapped with high-cost debt

In December last year, the Reserve Bank of India (RBI) observed that Indian banks were diverting lending away from the industrial sector towards retail loans as more and more Indians resorted to borrowing for financing consumption needs, from buying houses to smartphones.

Using loans to finance consumption needs was not a common practice in India for most of its modern history, but picked up over the last decade amid softening interest rates and a growing focus on retail lending by banks and non-banking financial companies (NBFCs), as per a report by Economic Times.

Companies such as HDFC and Bajaj Finance became major players riding on this wave of borrowing: over the past decade, HDFC grew by a whopping 3,600 per cent while Bajaj Finance went up 2,250 per cent.

Now, with rising interest rates, NBFCs are unlikely to be able to replicate such growth, while borrowers are likely to be strapped with high-cost debt.

Citing several examples from across India, the publication reported how many Indians, during the pandemic, got a rude awakening, with pay cuts inhibiting their ability to pay back loans that had piled up due to borrowing for consumption.

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"India is also copying the West. Credit cards, app loans, and buy now pay later schemes are basically a way of selling goods to people. Finance is easy in India now. As a result, the number of Indian households that are in debt and the amount they owe have increased," Harish B Parmar of Single Debt told ET, adding, "The rise in indebtedness is sharper among rural households, which is about 84 per cent, than urban, currently at 42 per cent."

To put this comment into perspective, outstanding retail loans in India as of March 2022 stood at a whopping Rs 34 lakh crore, just shy of outstanding industry loans that stood at Rs 35 lakh crore. Outstanding service sector loans, meanwhile, were lower than retail loans at Rs 31.5 lakh crore.

Additionally, in something that is in stark contrast to Western countries like the US, most of the borrowing by households in India has been for consumer durables rather than for assets such as real estate.

According to ET, while more than 75 per cent of retail loans in the US are home loans or auto loans, in India, home loans account for just 30 per cent of total household debt. The rest is made up of gold loans and other unsecured loans.

Indeed, according to RBI data, consumer durables saw the highest growth vis-a-vis borrowing, growing 89 per cent year-on-year to hit Rs 37,349 crore in FY22. Housing and auto loans, meanwhile, grew by 12 per cent and 14 per cent, respectively, in the same period.

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In addition to the growth in borrowing to finance consumer durables, gold loans also increased sharply during the Covid-19 pandemic period, growing by 194 per cent between October 2019 and October 2022, as households resorted to taking such loans to support consumption amid falling incomes.

In the same period, credit card loans grew by 57 per cent, another indicator of how falling incomes during the pandemic drove borrowing for consumption.

While debt levels are indeed rising in India, the silver lining is that India's household debt-to-GDP ratio is not as high as that of other emerging economies. While economies such as South Korea and China have household debt-to-GDP ratios of 105 per cent and 61 per cent respectively, India's is relatively low at 37 per cent, lower than the average for emerging economies, which stands at 51 per cent.

Experts also told the publication that household debt in India, despite the recent, sharp increase, remains manageable now.

That being said, if borrowing beyond means continues to grow unchecked, Indian households could well find themselves in a huge debt trap in the not-so-distant future.