Solution for high level of private debt of Indian economy

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The increasing global burden of private debt is largely is due to combination of business debt and household debt. Even though government debt grabs all the headlines, private debt is larger than government debt and has more impact on economic outcomes. Debt is a two-edged sword. Used wisely and in moderation, it clearly improves welfare. But, when it is used imprudently and in excess, the result can be disaster. For individual households and firms, over borrowing leads to bankruptcy and financial ruin. 

When a private debt is high, consumers and businesses have to divert an increased portion of their income to paying interest and principal on that debt resulting into less spending and investment. That is a real part of what is weighing on economic growth. After private debt reaches high levels, demand gets suppressed. Most middle and lower income households (where the highest rate of debt growth has been) as also most small and medium sized businesses, pay much higher rate of interest than money market rates. And in addition to interest, all such borrowers have to pay down the principal balance of loan.

Since GDP is largely the sum of  all spending, and thus income of households and businesses in an economy, if aggregate private debt to GDP has tripled which means that average businesses and households three times more debt relating to their income. Out of both Govt. and private debts, it is private debt that has the larger and more direct impact on economic outcomes, and addressing the issues associated with private debt is the more productive path of economic revival. Though stagnant incomes, underemployment and job insecurity are also the key reasons but the levels of private debt and its accompanying effect on growth is also an equally important reason. 

Once a private debt occurs, there are three ways to solve it - First increase income through a second job, Second selling assets and third cut expenses. Borrowings by Indian households - difference between gross financial savings and net financial savings - averaged 2.9% of GDP in six fiscal years between 2011-12 to 2016-17. A sharp increase was noticed to 4.3% in GDP in 2017-18. A swing was reported in 2019-20 -from 11.1% to 10.6% of GDP. 

Three points are worth repeating in the context of new data on household finances. First is that people react to economic shock, as the world is currently facing, whether it is a temporary or a permanent one. The rule to remember is to smoothen consumption by borrowing in case they think the shock is temporary. If the shock is permanent then smoothen savings by cutting consumption. 

Second, precautionary savings tend to increase when people face income uncertainty. People are holding more cash than before  as also prefer to park their funds in savings rather than in demand deposits. 

Third, a change in the financial decisions of the households both in terms of higher precautionary savings as well as lower borrowings. In other words, risk aversion by Indian households could mean greater demand for safe assets such as Govt. Bonds. However, it is a fact to note that a shrinking current account deficit will eat into some of the benefits of higher household financial savings in terms of funding the fiscal deficit. 


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