In pushing India’s stock market to an all-time high last week, investors seem to be drawing a smooth, straight line between a third term for Prime Minister Narendra Modi — their preferred and expected outcome of the ongoing general election — and soaring corporate profits. They might be ignoring an all-too-important speed bump: consumer debt.
A trifecta of slow wage growth, elevated interest rates, and heavy borrowing by the average household has weakened the spending impulse of more than 300 million families that drives 70% of gross domestic product. Equity markets aren’t too perturbed. Investors are betting on a post-election boom in private capital expenditure on the back of $534 billion in new infrastructure expected by Bloomberg Economics to come online by 2026, boosting India Inc.’s competitiveness and lifting the economy’s growth potential. More confident companies will also create better-paying jobs. Sooner or later, interest rates will start to decline, both at home and globally. Households’ financial crunch will ease.
Bond investors’ thinking is not too dissimilar: Unlike his opponents, the prime minister isn’t promising a dramatic expansion of the welfare state. (According to him, he has already spent $400 billion on cash handouts and free food for the poor in the past 10 years.) Modi will instead borrow to expand productive capacity. A cautious fiscal stance and expectations of a stable currency make India’s rupee-denominated government notes attractive. Borrowing dollars to buy Asian bonds has been unprofitable almost everywhere this year. India has been a notable exception.
Finally, not everyone agrees that households’ financial position is deteriorating. Yes, there has been an uptick in their liabilities. For only the second time on record, annual debt accumulation may have risen past 6% of GDP in the financial year that ended in March, according to Motilal Oswal Financial Services Ltd., a Mumbai brokerage. Net financial savings have slumped to a four-decade low. But at about 40% of GDP, the stock of borrowings is still low by global standards. China’s household debt is in excess of 60% of the economy, while it’s more than 70% in the US.
However, this sanguine view may be overlooking a key vulnerability. A big chunk of the consumer loans in India are for one to three years, which in the current interest-rate environment translates into an outlay of 11% to 12% of family income for debt servicing, compared with 8.5% in China and 6% to 9% in advanced economies, according to Motilal’s Chief Economist Nikhil Gupta.
Not only is the debt-servicing burden high, it’s becoming more onerous as borrowing costs outpace increase in incomes. The only other time Indians were borrowing more heavily than now was before the 2008 Global Financial Crisis. Back then, incomes were growing faster than interest rates, as economists Zico Dasgupta and Srinivas Raghavendra at Azim Premji University in Bengaluru noted recently. This time, people may be borrowing not out of optimism, but to meet day-to-day living costs — inflation is the second-biggest issue in this poll after unemployment.Growth in private final consumption expenditure collapsed to 3% last fiscal year in inflation-adjusted terms, when the broader economy expanded by 7.6%. This may be India’s new model of growth with Chinese characteristics: heavy on investment, light on consumption. But the smaller economy lacks resources for financing this kind of expansion for long. The world is happy to lend as long as India’s current-account gap is restricted to about 1% to 2% of GDP. A bigger shortfall, for instance during a spike in imported crude oil prices, has been destabilizing before. It could be again.Which is why the declining trend of households’ net financial savings is disconcerting. A durable slump, combined with a higher investment rate, “has the potential to widen India’s external deficit,” writes Gupta, the Motilal Oswal economist. Policymakers “must ensure to push India’s total savings higher before a revival in its investment rate.”
For that, households may need to earn more. Trouble is, disposable incomes are weighed down by high levels of informal work, which pays badly — or, as in the case of unpaid family labor, nothing at all in cash. Since the pandemic, even the steady migration of youth out of agriculture to more productive, formal sectors has suffered. That has led to a credit binge.
Rebuilding savings will require income-augmenting policies. Rahul Gandhi, Modi’s main challenger, is proposing paid internships, cash support to poor families and jobs in maintenance of city infrastructure. The market, however, prefers investment-led growth, supported by the exuberant spending of a tiny affluent class. The luxury-auto market grew twice as fast last year as mainstream cars. The 1,000% jump in high-end property launches over the past four years has dwarfed affordable housing. In this election, Gandhi’s Congress Party did try to make extreme inequality under the 10 years of Modi’s rule resonate with voters as a political issue. To what extent the effort succeeded will be known when ballots are counted next Tuesday.
Firms, however, are happy with the infrastructure push, particularly into highways and power. As a recent Bloomberg News article notes, the refrigerated trucks of Vadilal Industries Ltd., a maker of ice cream from Modi’s home state of Gujarat, don’t break down as often as they did before on potholed roads and its products can remain frozen even in remote villages. But in a county where per-capita annual consumption is less than half a liter, surely people should also have the money to buy more ice cream? In wanting politics and policies to remain steady, neither India Inc. nor investors seem to realize the risk to financial and societal stability when ordinary families can afford very little of anything.
Whoever forms the next government in New Delhi must first repair the household balance sheet.
(This is a Bloomberg Opinion copy)