UPSC EDITORIAL ANALYSIS : India’s looming financial crisis

Source: The Hindu

• Prelims: Indian Economy(GDP, BOP, GVA, Economic reforms etc

• Mains GS Paper III: Indian economy and issues related to planning, mobilization of resources, Effect of liberalization on the economy etc

ARTICLE HIGHLIGHTS

• In 2023, the Board of Directors of the International Monetary Fund (IMF) praised the performance of the Indian financial sector.

• The 2024 review of the National Council of Applied Economic Research cheered a 20% increase in banks.

INSIGHTS ON THE ISSUE

Context

International Monetary Fund (IMF) projections:

• India is currently the fifth largest economy in the world in U.S. dollar terms

• It projects that India will be the third-largest economy by 2027.

• India has registered the highest growth rate amongst G20 countries, surpassing China’s for two successive years.

• IMF’s historical data shows that India took six decades (1947 to 2007) to cross the one trillion-dollar GDP mark in 2007 ($1.2 trillion). It took India just seven years to become a $2 trillion economy in 2014. It added another $1.2(one point two)trillion by 2021.

• It took India just seven years to become a $2 trillion economy in 2014.

• It added another $1.2(one point two)trillion by 2021.

• If India hits the IMF’s projected figure of $5.2(five point two)trillion by 2027: It would be adding $2 trillion in just six years.

Challenges:

• The credit growth deflects attention from the deep-rooted jobs’ and human capital deficit.

• When lending expands, the financial sector looks in good health as new loans pay off old ones. It collapses when lending slows and options for more loans to repay earlier obligations get shut. Heavily indebted households and businesses sharply reduce spending to repay their debt, causing an economic crunch.

• It collapses when lending slows and options for more loans to repay earlier obligations get shut.

• Heavily indebted households and businesses sharply reduce spending to repay their debt, causing an economic crunch.

Issues with Household lending(between 25% and 30% a year):

• Financial intermediaries have pushed their loans, many lower- and middle-income households have viewed the funds as easy cash to make ends meet or to buy homes, gadgets and cars, pay for education, and indulge in ‘lifestyle’ spending, including vacations and elective medical procedures.

• including vacations and elective medical procedures.

• A household debt boom is a quintessentially “bad” boom. It does not add to productive capacity but, instead, bids up domestic prices, making the country less competitive.

• It does not add to productive capacity but, instead, bids up domestic prices, making the country less competitive.

• Economists Atif Mian and Amir Sufi report: the higher the household debt burden, the steeper the crash that follows.

• The financial crisis will cause not just economic pain but will also degrade the economy’s long-term well-being.

• Unable to generate job-rich manufacturing growth, successive policymakers have pushed the financial services industry to raise headline GDP growth rates.

• Indian household debt, at 40% of GDP, is low by international standards, but household debt-service-to-income ratio, at 12%, is among the highest in the world because of high interest rates and predominantly short duration loans.

• because of high interest rates and predominantly short duration loans.

• The Indian household debt-service ratio is alarmingly similar to that in the United States and Spain just before their 2008 financial crisis, when high household debt-service burdens precipitated major economic downturns.

• Despite buoyant credit growth, household consumption is increasing at an excruciatingly slow pace. Households are struggling; their savings rates have declined and they are boosting meager consumption by borrowing money.

• Households are struggling; their savings rates have declined and they are boosting meager consumption by borrowing money.

#### Issues with Financial services industry:

#### ● Indian-style liberalization has promoted a large and chaotic financial services industry.

#### ● Scheduled commercial banks and major non-banking financial institutions (NBFCs), have a history of rogue behavior.

#### ● Thousands of smaller players, including fly-by-night NBFCs and new fintechs operate in dubious ways.

• There are too many financial services’ providers with too few options to lend for productivity-enhancement projects.

• Over time, lending opportunities have narrowed as the Indian corporate sector has reduced its investment-GDP ratio and borrowing pace.

• Financial institutions have been under great pressure to generate profits.

• After COVID-19, financial services providers redirected lending toward households eager to borrow in lieu of stagnant incomes.

• The newly emergent fintechs led this charge by offering loans to desperate households at extortionary interest rates. A new set of scammers preyed on the gullible. Yet, some borrowers became addicted to such loans.

• A new set of scammers preyed on the gullible.

• Yet, some borrowers became addicted to such loans.

• Growing share (approaching a quarter) of household loans is “unsecured,” backed by no collateral.

• Unsecured consumer borrowing is credit card debt(January 2024): Indians owned almost 100 million credit cards, up from 20 million in 2011.

• While the cards bring convenience, aggressively peddling them to low-creditworthy individuals builds up stress for both borrowers and the financial system. RBI: explosive credit card growth has attracted “below-prime” or riskier borrowers.

• RBI: explosive credit card growth has attracted “below-prime” or riskier borrowers.

Way Forward

• Preventing the crisis requires surgically downsizing the financial services industry to better match lending capacity and productive borrowing needs weakening the rupee to help expand exports and cushion the downturn when it comes.

• weakening the rupee to help expand exports and cushion the downturn when it comes.

• Rapid credit growth and an overvalued exchange rate are a lethal combination.

• Joan Robinson’s dictum that finance must follow growth Indian policymakers have committed themselves to the notion that finance will spur growth It will help overcome the country’s severe developmental handicaps in human capital and other public goods. Policymakers are committed to a strong exchange rate as a metric of the nation’s virility.

• Indian policymakers have committed themselves to the notion that finance will spur growth

• It will help overcome the country’s severe developmental handicaps in human capital and other public goods.

• Policymakers are committed to a strong exchange rate as a metric of the nation’s virility.

• As the risks of a financial crisis grow, an acute job shortage persists, reflected most poignantly in a catastrophic regression of the workforce back to agriculture.

QUESTION FOR PRACTICE

Do you agree that the Indian economy has recently experienced recovery ? Give reasons in support of your answer.(UPSC 2021) (200 WORDS, 10 MARKS)

Editorial Analysis – 12 June 2024