The Coming Financial Crisis in India

While rapid credit expansion frequently heralds prosperity, it can also trigger financial disasters. India is confronted with the illusion brought to light by Carmen Reinhart and Kenneth Rogoff, in which markets and governments downplay previous catastrophes by exaggerating the nation's performance and saying "this time is different."

India's Vulnerability in Finances

• Overhyped Expectations: Because of politicians who constantly tout India's achievements, the nation finds itself in a vicious cycle of overhyped expectations. The "this-time-is-different" narrative promises equality and growth by highlighting India's digital infrastructure for financial innovation and inclusion. But this has resulted in more borrowing and an unregulated financial industry.
• Decades of Economic Policies: This position has been exacerbated by recent government periods, but it is also the result of three decades of economic policies. Policymakers have turned to the financial sector, which has contributed more than 25% of GDP growth in the last ten years, to increase GDP growth rates since they have been unable to produce job-rich manufacturing expansion.

Acclaim for the Rise in Lending

• IMF's Acclaim: The lending boom has received recognition from both domestic and foreign analysts. The IMF commended India's financial system in December 2023, highlighting the country's low non-performing asset level and robust increase in bank lending.
• Support from Domestic Analysts: In a similar vein, the National Council of Applied Economic Research's March 2024 evaluation applauded a 20% rise in bank lending. Amid stagnating industrial lending, they interpreted the surge in personal loans as a harbinger of promising times ahead.

The Impending Financial Crisis in India

• Ignoring Underlying Deficits: The expansion of credit ignores the underlying deficiencies in human capital and employment, which puts us in peril. The financial industry appears robust as lending increases and new loans settle existing ones. But things fall apart when financing slows down and opportunities for new loans disappear.
• Household Debt Boom: By encouraging loans, financial intermediaries push lower- and middle-class households to spend money on things like houses, cars, technology, education, and lifestyle items. This surge in household debt is, nevertheless, inherently dangerous. It lowers competitiveness by increasing domestic prices rather than increasing production.
• Economists Atif Mian and Amir Sufi issue a warning, stating that heavier family debt loads cause crashes to be more severe. An economic crisis resulted from heavily indebted families and corporations drastically cutting expenditure to pay off debt. With the rate at which home loans is expanding—between 25% and 30% annually—this situation is probably going to recur in India.
• Problems with the Stock Market and Exchange Rates: The bad credit bubble is being compounded by the stock market's upward movement, which is unrestrained by low business investment and sluggish consumer spending. Additionally, the exchange rate is overpriced, and Indian authorities have a tendency to falsify data.

The Dangers of the Unstable Indian Financial System

• Financial Services Sector: With big banks and NBFCs coexisting with a plethora of smaller firms, India's financial services sector has become disorganized as a result of deregulation. But as lending options have decreased, institutions are being forced to pursue profits more aggressively.
• Transition to Household Lending: In the wake of COVID-19, fintech companies began to offer high-interest loans to households. Due to the dependence of many borrowers on these loans, unsecured household debt accounted for a sizeable amount of total debt.
• Credit Card Ownership Surge: Although aggressive marketing targeted at those with poor creditworthiness created concerns, credit card ownership increased in India. Macroeconomic risk: many were enticed by incentives and promises and were mired in debt.
• Slow Household spending: In spite of the expansion of credit, household spending is still slow. An elevated household debt-service ratio, comparable to pre-crisis levels in other nations, portends impending difficulties. The crisis may intensify quickly if defaults lead to financial distress and an eventual slowdown in the economy.

Taking Care of the Crisis

• Reducing the Financial Sector: Reducing the Financial Sector is necessary to balance lending capacity with productive borrowing demands, and to avoid India's exaggeration. It is also essential to weaken the rupee in order to increase exports and mitigate the recession.
• Difficulties with Policy Change: It appears doubtful that policies will change. Despite the concerns, Indian authorities think finance would propel growth. Sturdy currency rates are likewise highly valued by them. A significant employment scarcity and the impending catastrophe are forcing many people to return to agriculture.
• Reevaluating Risk Models: Banks and Non-Bank Financial Companies (NBFCs) could have to review their unsecured loan lending policies and risk models. Prioritizing creditworthiness evaluations and looking into different approaches can help them control risk while continuing to provide loans.

• Diversifying Loan Portfolios: To counteract the effects of greater risk-weighting on unsecured loans, financial institutions may choose to pursue other creditworthy groups or change their focus to more secured lending.

• Learning from the Global Financial Crisis of 2008: India must take note of the lessons that the Global Financial Crisis of 2008 taught us, especially the importance of strict risk assessment, strong financial regulation, and more transparency. The crisis also highlighted how intertwined the world's financial systems are and how important it is for nations to work together, highlighting the critical role that central banks play in maintaining economic stability through prudent monetary policy.

In summary

India's over dependence on credit is comparable to a fast car heading off a cliff without brakes. Sadly, it appears that the country's leadership is unaware of the dangers, which means that the weak will have to carry the brunt of the crisis and inequality will only worsen. In order to move India's economy toward becoming a $5 trillion economy, it is imperative that the overhyped aspirations become reality and that digital financial inclusion promote growth and equality.