A recent RBI study shows that the economy is moving towards healthy and prime borrowers. However, it is concerning that a sizable portion of borrowing is being done for consumption, as this indicates macroeconomic problems in the economy.
Even while consumers are borrowing more money, particularly on credit cards, a robust labour market today offers a large number of employment and growing salaries that make it simpler for consumers. Credit delinquencies remain well below their pre-pandemic levels, which were already very low. However, if policy risks come to pass and the job market and economy stall, this may alter. Then, widespread consumer credit may endanger people’s financial stability and perhaps the economy. According to the Federal Reserve, consumers are still taking out ever-larger loans for credit cards, school loans, auto loans, and other non-mortgage debt. The overall amount of consumer debt was $4.8 trillion as of December 2022.
Credit cards have been a major factor in the rise in consumer debt in recent years. By December 2022, total credit card debt as a percentage of after-tax income had increased from less than 6% in 2021 to 6.3%. However, it is still less than the 6.6% of after-tax income that it was before the epidemic. In April 2022, the ratio of other consumer credit to after-tax credit hit a record high of 18.9%, and it has remained there ever since. Crucially, variable interest rate debt has contributed significantly to the recent expansion of consumer borrowing.
These loans are usually taken out by those who find it difficult to pay their payments in any other way. They take out loans to pay for medical bills, purchase a new automobile they need to travel to work and cover unexpected costs like a sick family member. Most people don’t take out loans for no reason. People who don’t have much saved for emergencies also take out loans. After an initial spike brought on by pandemic aid in 2021 and early 2022, consumer debt has increased coupled with a decline in liquid reserves. Therefore, rising financial difficulties in many households are reflected in the rise in consumer debt.
Factors leading to rising Consumer Credit Risks for households
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India’s rising household debt
The rising household debt in India is highlighted in the Financial Stability Report (FSR) 2024. Household debt increased from 36.6% of GDP in June 2021 to 41% in March 2024 and then to 42.9% in June 2024. Despite being lower than many emerging nations, India’s household debt is steadily rising, which is concerning.
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Changing How Borrowed Money Is Used
Although household asset holdings have decreased from 110.4% of GDP in June 2021 to 108.3% in March 2024, debt is often taken on to purchase assets. This may be a sign of economic weakness as it implies that more loans are being used for consumption as opposed to asset construction.
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Borrowers’ and borrowers’ health
Several indicators suggest that the borrowing structure is sound, even in the face of growing household debt. The rise in general borrowing is due to an increment within the number of borrowers instead of an expanded obligation per borrower. The extent of sub-prime borrowers (those with lower credit appraisals) has declined, whereas prime and super-prime borrowers presently hold about two-thirds of the add-up to family obligations. Super-prime borrowers, who have the most elevated credit quality, are borrowing more, but primarily for resource creation rather than consumption.
Effects of Consumer Borrowing on Credit Growth
Since the pandemic, borrowing by individual consumers has been a significant driver of credit expansion. In response to this rise, regulatory measures were executed in September 2023, which slowed down the credit growth.
- The downturn has led to a move toward healthier borrowers, reducing risky lending. Increasing Consumption Loans and Income Inequality.
- The percentage of loans taken for consumption has risen, with lower-income people borrowing mostly for everyday necessities.
- Families earning less than 5 lakh per year mainly utilise unsecured loans (such as credit card debt) for consumption, whereas wealthier families borrow for housing.
- Subprime borrowers accept 50% of loans for consumption, whereas superprime borrowers utilise 64% for asset building.
Rising Debt Stress among Lower-Income Groups
- Personal and credit card loan defaults rose in September 2024 compared to September 2023, indicating financial hardship among low-income borrowers.
- Many consumers with credit cards or personal liability also have automobile or home loans.
- A default on one loan causes all of the borrower’s debts to be classed as non-performing loans (NPLs), creating financial risks.
- Rising default rates on unsecured loans may lead to an economic downturn.
Impact on Economic Development and Multiplier Effect
Lower-income families contribute more to the economy’s growth because they invest more earnings. But if they are in debt, some of their income is used to pay loans rather than for consumption. This decreases the income multiplier, resulting in lesser economic growth from the same investment amount. Income reductions in taxes may not benefit poorer people with significant debt, thus hindering economic development.
Implications on economy
Credit card transactions give retailers more safety than traditional payment methods such as checks, lowering the high risk of fraud and theft. Banks now assess individual creditworthiness, relieving merchants of the load. Cardholders, issuing banks, merchants, acquiring banks, and independent sales groups all play a role in credit card transactions. The complex network, which credit card companies and transaction networks support, enables perfect transactions.
The use of credit cards increases GDP and private spending. Gains in private consumption due to card use result in equivalent gains in GDP.
Card penetration as a percentage of overall personal consumption expenditures Annual card usage growth compared to personal spending and the percentage of GDP allocated to personal consumption. According to the report, rising card use added $245 billion to spending in 70 countries from 2015 to 2019. Increased card penetration is also projected to account for 0.08% of the 3% increases in actual gross domestic product over the period.
Card utilisation has climbed the most prominently in Greece (0.31%), Uruguay (0.25%), Puerto Rico (0.24%), Russia (0.16%), the United Kingdom (0.15%), and South Korea (0.15%). The anticipated GDP versatile modulus, or responsiveness of GDP to increments in card infiltration, for progressed economies is considerably bigger than it is for creating markets since card infiltration is higher. The estimate is more than twofold in industrialised countries, where entrance is approximately 49%, compared to countries with developing economies, where immersion midpoints are 20%.
This is hardly unexpected given that industrialised nations have better-established payment networks, more flexible card users, and environments in which the majority of retailers accept cards. In contrast, payments made in cash are still more common. In rising economies, analysing the effect of future card usage on GDP is more than just an intellectual exercise. As more customers worldwide switch from paper to payment cards, our findings quantify the beneficial macroeconomic impact of this structural trend.
Conclusion
Credit cards are a significant factor in the global economy because of their transactional efficiency, customer access to credit, and overall consumer confidence in the payment system. Card acceptance and use are favourably connected with economic growth, which boosts GDP. Payment cards also boost customer confidence and increase access to credit. Furthermore, it promotes financial stability for the most disadvantaged by providing a safe and effective cash alternative for people who do not have access to traditional banking systems.
