RBI governor must ease credit, but not too much

By Andy Mukherjee

Sanjay Malhotra, the new Reserve Bank of India governor, is right to unwind some of his predecessor’s hawkish controls on a runaway consumer-credit boom. There was a time to throw sand in the wheels of commerce. Right now, though, a sputtering growth engine needs lubrication. 

Still, Malhotra must be cautious. There is a crack in the structure of the world’s fastest-growing major economy. Speeding up subprime loans could be risky down the road. 

Effective April 1, banks will set aside less capital on loans to better-rated nonbanking financial companies. The monetary authority has also lowered the risk weights on microfinance loans for consumer credit to 100%, restoring them to their pre-November-2023 levels. Back then, Shaktikanta Das, the former RBI chief, had raised the weights to 125%.

The capital thus freed up could fuel banks’ own lending. The sharp downtrend in their advances to shadow lenders — who ultimately serve less creditworthy borrowers — should also reverse.

Both of those outcomes will be timely. Gross domestic product may have grown 6.5% in the year that ends March 31, according to the government’s estimates, slowing from 9.2% in the previous 12 months. The next year’s forecast doesn’t herald much of a pickup, either.

And those official statistics may not be capturing the full extent of the funk in consumer demand in urban areas where wages are stagnant, and jobs are under threat from artificial intelligence. Amid a $900 billion rout in the stock market, and with US President Donald Trump’s trade war creating uncertainty for output, prices and interest rates globally, it’s understandable that policymakers want credit to flow more easily.

Yet Malhotra must know that his recent move is just a temporary solution. The 8% GDP growth that authorities say they want to sustain — to propel a lower-middle-income economy to a developed one — will need a more concrete foundation than a hole filled with consumer credit. 

Eight years ago, banks and finance companies gave out 2.5 million advances of less than 100,000 rupees ($1,150). Last year, there were 122 million of such small-ticket loans, accounting for 88% of all personal credit origination, according to Blume Ventures, a Mumbai-based early stage venture-capital investor that releases a popular annual report. Thanks to rapid digitization, which has quickened credit checks and approvals, finance companies and banks were able to push out $100 billion in new personal loans out the door in 2024, a six-fold jump from 2017.

That’s a big addition to household liabilities in a short time. Where’s the appetite for this borrowing coming from? 

The Blume report offers clues. The richest 30 million households in the most-populous nation have an aggregate purchasing power similar to Mexico’s. Their consumption is powering the economy. The next 70 million, earning about $3,000 per capita annually, are on their way to rivaling Indonesia’s living standards. They are trying to mimic the spending choices of the top earners who are five times richer, on average.

The remaining 200 million families — 1 billion people — are India’s equivalent of sub-Saharan Africa, dipping into savings to survive. They have no money for discretionary expenditure. 

The research doesn’t say it, but my guess is that “India 1,” as the authors term the top consuming class, is financing both the aspirations of “India 2,” and the desperation of “India 3.” The interest payments on the borrowings by the latter two groups is flowing to the first, making it wealthier still. And therein lies the structural flaw in the economy.

A 2021 paper by economists at Princeton, Harvard and the University of Chicago argues that instead of productive investment, the “saving glut of the rich” Americans — accumulating over four decades — drove “dissaving by the non-rich and dissaving by the government.”

It’s possible that something similar is afoot half a world away. Income and wealth distribution in the fifth-largest economy is now more unequal than it was a hundred years ago under the British Raj. That would explain the surge in small-ticket personal loans. It would also explain why a middle class stuck in a cycle of mediocre work, poor pay and heavy indirect taxes lost billions of dollars trading options, enriching the likes of Jane Street Group. The derivatives market witnessed a 40-fold jump since 2019 before regulators stepped in to stop the madness.  

New Delhi, too, has become dependent — not only on the savings glut of the local wealthy, but of rich investors globally. Without the $12 billion it earned from a long-term capital gains tax that even foreigners have to pay, the government’s effective revenue deficit would have been 13% higher in 2022-23. But when that fickle source of tax income comes up short, the axe of deficit reduction may fall on welfare programs. Which would leave poor households more reliant on small-ticket loans that groups of women borrowers can obtain from microfinance firms.  

That’s the business model of microfinance in India, and it has a crisis once every few years. A recently released report by a government think tank shows a 42%, one-year jump in the number of women borrowers actively monitoring their credit. Much of it may be anxiety about default, passing off as empowerment. While lowering the risk weight on consumer credit via microfinance, the Reserve Bank will hopefully remain alive to the risk.

While he can’t do much about jobs or wages, Malhotra could tell his bosses in New Delhi to stop dreaming about a developed society until they have fixed the corrosive inequality hollowing out the economy’s foundation. The rest is up to them.