• UGI USER
  • Jun 12, 2024
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INDIA LOOMING FINANCIAL CRISIS

Syllabus:

GS-3:

  • Indian Economy and Issues Relating to Planning.

Focus:

  • India’s financial landscape is facing scrutiny due to rapid credit growth, particularly in household lending, raising concerns of an impending financial crisis.
  • Analysts warn that the current economic exuberance, coupled with a chaotic financial services sector, may lead to severe economic repercussions if lending practices are not regulated.
source:theweek

Understanding the “Rapid Credit Growth Risks Crisis”:

  • Credit Growth and Crises: Rapid credit growth often leads economies into financial crises, creating temporary prosperity that ends in economic turmoil.
  • Financial Booms as Myths: Each financial boom is touted as innovation, but historically, they are driven by irrational exuberance.
  • Historical Ignorance: Economists Reinhart and Rogoff explain that despite past crises, governments and markets often believe “this time is different.”
  • False Narratives: Policymakers sometimes perpetuate a dangerous narrative that current economic conditions will prevent previous mistakes from recurring.
  • Economic Illusions: Such narratives often lead to poorly regulated financial sectors and consumers living beyond their means, creating unsustainable lending booms.
Understanding Concept of Credit Growth:

  • Financial Liberalization: Intended to foster financial deepening.
  • Capital Inflows: Increases funds available to banks.
  • Result: Enhanced credit availability leads to rapid credit growth.
  • Major Sources of Potential Trouble:
  • Mudra Credit: Loans to non-corporate, non-farm small/micro enterprises.
  • Kisan Credit Cards: Credit for agricultural sector needs.
  • Credit Guarantee Scheme for MSMEs: Collateral-free loans for micro and small enterprises.

What is Mudra Credit?

  • Purpose and Structure: Mudra Yojana provides loans up to ₹10 lakh to non-corporate, non-farm small/micro enterprises.
  • Loans are disbursed through commercial banks, regional rural banks (RRBs), small finance banks, cooperative banks, microfinance institutions (MFIs), and non-banking financial companies (NBFCs).
  • Categories: The scheme operates under three categories:
  • Shishu: Loans up to ₹50,000
  • Kishore: Loans from ₹50,001 to ₹5 lakh
  • Tarun: Loans from ₹5,00,001 to ₹10 lakh
  • Objective: The primary aim is to fund the unfunded, meeting the financial needs of micro units and small entrepreneurs.
  • Potential Trouble: The rapid disbursement of loans without adequate checks and balances can lead to a surge in non-performing assets (NPAs), posing a risk to financial stability.

What are Kisan Credit Cards?

  • Objective: The Kisan Credit Card (KCC) scheme aims to meet the comprehensive credit requirements of the agriculture sector by providing financial support to farmers.
  • Origin: Introduced based on the recommendations of the R.V. Gupta committee.
  • Credit Facilities: The scheme offers short-term credit limits for crops and term loans for various agricultural needs.
  • Potential Trouble: The reliance on KCCs can lead to over-borrowing, especially if crops fail or market prices drop, increasing the likelihood of defaults and financial stress in the agricultural sector.

About Credit Guarantee Scheme for MSMEs:

  • Purpose: The scheme was introduced to provide collateral-free credit to the micro and small enterprise sector.
  • Implementation: Managed by the Ministry of Micro, Small and Medium Enterprises in association with the Small Industries Development Bank of India (SIDBI).
  • It established the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) to implement the scheme.
  • Objective: To enhance the availability of credit to MSMEs, fostering their growth and development.
  • Potential Trouble: The scheme’s collateral-free nature may lead to risky lending practices, with insufficient assessment of borrowers’ creditworthiness, potentially resulting in high default rates.

Understanding Household Debt:

  • Definition: Liabilities requiring interest or principal payments by households to creditors at fixed future dates.
  • Components in India: Includes consumer durables, housing loans, and personal loans for education, medical expenses, etc.

Current Status:

  • Household Debt: Reached an all-time high of 40% of GDP by December 2023.
  • Net Financial Savings: Dropped to their lowest level, approximately 5% of GDP during the same period.

About Unchecked Optimism in India:

  • India’s Credit Boom: India is currently experiencing a credit surge, driven by a belief in the transformative power of its digital infrastructure.
  • IMF and NCAER Praise: Both international and domestic analysts have praised the performance of India’s financial sector, citing robust growth and low non-performing assets.
  • Misleading Applause: Celebrations of credit growth obscure deep-rooted issues like job deficits and inadequate human capital.
  • Temporary Prosperity: Financial sector health appears strong during lending booms as new loans repay old ones, but this stability is precarious.
  • Impending Crisis: When lending slows, heavily indebted households and businesses will drastically cut spending, leading to an economic crunch.

The Dangers of Household Debt:

  • Rapid Household Lending: India is witnessing a rapid expansion of household lending, growing at rates between 25% and 30%
  • Consumption-driven Borrowing: Many households borrow to meet everyday expenses or indulge in non-essential spending, increasing financial vulnerability.
  • Unproductive Debt: Household debt does not enhance productive capacity and tends to inflate domestic prices, reducing competitiveness.
  • Economists’ Warnings: High household debt burdens, as warned by economists like Atif Mian and Amir Sufi, lead to steeper economic crashes.
  • Vulnerability Signals: India’s household debt service-to-income ratio is alarmingly high, comparable to levels in the U.S. and Spain before their 2008 crisis.

Key Indicators of an Emerging Crisis:

  • Stock Market Disconnection: The Indian stock market is rising despite weak corporate investment and consumer spending.
  • Overvalued Currency: An overvalued rupee exacerbates economic imbalances, making Indian goods less competitive globally.
  • Questionable Data: Authorities often present overly optimistic data, masking underlying economic weaknesses.
  • Three Decades of Policy: The current situation stems from decades of policies emphasizing financial sector growth over job-rich manufacturing growth.
  • Financial Services Chaos: A large, chaotic financial services industry, with both reputable and dubious players, adds to the instability.

Structural Issues in Financial Services:

  • Numerous Providers: India has a plethora of financial service providers, but few options for productivity-enhancing projects.
  • Narrowing Opportunities: The reduction in corporate sector investments has limited lending opportunities, pushing financial institutions to seek easy profits.
  • Post-1991 Liberalization: Economic liberalization since 1991 has led to various financial scams and a shift towards household lending.
  • Post-COVID Lending: After COVID-19, financial institutions increasingly lent to households to maintain profits amidst stagnant incomes.
  • Predatory Lending: Fintechs have exploited desperate households, offering high-interest loans and leading to widespread financial stress.

About the Credit Card Conundrum:

  • Unsecured Borrowing: A growing share of household loans, including credit card debt, is unsecured, posing significant risks.
  • Credit Card Boom: The number of credit cards in India has surged, from 20 million in 2011 to almost 100 million in
  • Borrower Vulnerability: Aggressive promotion of credit cards to low-creditworthy individuals increases stress on borrowers and the financial system.
  • Debt Trap: Many individuals, like the fictional Rohan, fall into debt traps, using loans to pay off previous credit card debts.
  • Macro Threat: The widespread reliance on credit cards and unsecured loans creates a macroeconomic threat due to potential widespread defaults.

Structural Risks and Economic Impacts:

  • Debt Service Burdens: India’s household debt-service-to-income ratio is one of the highest globally, similar to pre-crisis levels in other countries.
  • Savings Decline: Households are increasingly borrowing to supplement their declining savings rates.
  • Repayment Challenges: Eventually, the inability to repay old loans with new ones will lead to consumption contraction and defaults.
  • Cascading Defaults: Initial defaults can trigger a chain reaction due to the interconnectedness of banks, NBFCs, and fintechs.
  • Economic Contraction: The resulting economic contraction will further distress the financial sector, exacerbating the crisis.

A Call for Policy Change:

  • 2024 Election Impact: The 2024 general elections might diffuse some hype but could also trigger a crisis if credit growth suddenly stops.
  • Downsizing Financial Services: Preventing a crisis requires reducing the financial services industry’s size to align with productive borrowing needs.
  • Exchange Rate Adjustment: A weaker rupee could help expand exports and cushion the economic downturn.
  • Policy Inertia: Despite the risks, policy changes are unlikely due to entrenched beliefs in finance-driven growth.
  • Long-term Consequences: Without intervention, India’s financial strategy risks leading to greater economic inequality and deeper employment crises.

Way Forward:

  • Strengthen Regulations: Implement stricter regulations on lending practices to ensure financial stability and prevent excessive risk-taking.
  • Promote Productive Investments: Redirect credit towards productive sectors like manufacturing to enhance job creation and sustainable growth.
  • Enhance Financial Literacy: Increase awareness among consumers about the risks of over-borrowing and promote responsible financial behavior.
  • Monitor Household Debt: Establish mechanisms to monitor and manage household debt levels, ensuring they remain within safe limits.
  • Adjust Exchange Rate Policy: Devalue the rupee to boost export competitiveness and mitigate economic imbalances, cushioning potential downturns

Conclusion:

India’s unchecked credit boom, particularly in household lending, poses significant risks to its financial stability. Without regulatory intervention and strategic policy shifts, the country could face a severe financial crisis, exacerbating economic inequalities and impeding long-term growth prospects.

source:

https://www.thehindu.com/opinion/lead/indias-looming-financial-crisis/article68278359.ece#:~:text=The%20source%20of%20the%20impending,meagre%20consumption%20by%20borrowing%20money.

Mains Practice Question:

Discuss the potential risks associated with rapid credit growth in India’s financial sector. How can policymakers address these risks to prevent an economic crisis? Illustrate with examples from recent trends and historical precedents. (250 words)