Household deleveraging is the new hotspot for policy attention, RBI may have to consider a deeper interest rate cut in order to restore confidence
The recent publication of household financial assets-liabilities for 2019-20 (RBI Bulletin, June 10, 2020) is a startling revelation of deleveraging consumers cutting back expenditures. Private consumption expenditure grew its slowest in six years as household borrowings contracted a sharp 22% last year. Real consumer spending paced slower than even 2012-14, years of sharp fiscal compression and taper shock. The data adds a new, demand dimension to the pre-Covid slowdown that, until now, is a supply-driven story with financial sector troubles at the heart. It underlines in bold the long, dark shadow the pre-Covid consumption slide casts upon future recovery prospects. A dismal portent even if Covid hadn’t struck, the critical policy question is how to avert a deeper depression in consumer demand in a Covid-plus situation.
Financial liabilities of households reduced Rs 1.5 trillion in FY20 over the previous year, a 1 percentage point decline relative to aggregate output. The moderation in borrowings caused net financial savings of households to increase 0.5 points as share of GDP (almost Rs 2 trillion), faster than bank deposits grew. The RBI study speculates raised income uncertainty as possible trigger for deleveraging, besides tighter bank credit.
However, a longer look at relevant macroeconomic aggregates shows the steady slowing of private consumption after FY17 turned into a steep, 2.5 percentage point fall in 2019-20 (see graphic). That consumer spending even in the interval was heavily propped by borrowings, which outpaced disposable income growth, explains the sudden collapse. It was always unsustainable.
A 22% growth in household financial liabilities in FY17—the year of demonetisation—more than doubled to 58% in FY18, with a 4% increase in FY19. As gross national disposable income (GNDI) growth maintained around 11.1% in this period, borrowings grew double its pace in FY17 and more than five times in FY18! This propped private consumer spending that in real terms, has still slowed after its 2016-17 peak. In FY18, nominal private consumer expenditure was extensively credit-fuelled but nevertheless slowed 1.7 percentage points, signalling lesser bang from larger borrowings. Last year, disposable income growth plunged to 7.1%, i.e. before Covid arrived. Nominal and real private consumption expenditure growth plunged a respective 3 and 2 percentage points as households sharply cut back consumption, spent less and repaid debts.
On one hand, this is a classic play out of how borrowings-fuelled consumption eventually becomes unsustainable, sometimes abruptly with change in expectations – households’ current and future income perceptions fell steeply between March-July 2019. The signs were already there, e.g. increasing relative delinquencies in consumer credit across financial intermediaries—NBFCs and HFCs (auto, home and personal loans and against property), public sector banks (loans against property)—analysed in RBI’s Financial Stability Reports (June & December 2019) from TransUnion CIBIL data.
Leaving this aside, although it matters for future revival, the disturbing trend is aggregate consumer preference to spend less, reduce liabilities, and depend less on borrowings. Borrowing to tide over a downturn when incomes temporarily decline is the classic desired response for consumption smoothing: consumers can maintain living standards until the fall in incomes restores, enabling policymakers to stabilise aggregate demand until emergence of a self-sustaining upturn.
The concern compounds because household deleveraging and harsh spending cutbacks occurred within a very aggressive monetary policy context: From February 2019 to the third week of March 2020, or before Covid, RBI cumulatively reduced its policy rate 135 basis points, tied it to bank loan rates for quicker transmission, provided abundant liquidity, directly intervened to lower long yields and targeted credit support, amongst others. Against this monetary force, consumer spending barely stirred to life as observed from collapsing sales of cars, durable goods and other interest-sensitive components.
The ineffectiveness of monetary policy in demand management is disturbing. It is largely attributed to the blocked credit channel, incomplete transmission by banks and their risk-aversion, the prevalence and persistence of fear, lack of confidence in the broader financial system originating from the IL&&FS default followed by others, illiquid NBFCs with impending insolvencies in some, and so on. Undoubtedly, these are conspicuous issues and policies rightfully attended to these and get the financial sector to resume normal functioning.
These features characterised the pre-Covid economic slowdown as one driven by supply-side issues, rooted significantly in persisting financial sector weaknesses. While the reading or diagnosis is entirely valid, this also inspired belief that resolving them was the key to recovery. But the household net financial savings data for FY20 and its relation with associated macroeconomic aggregates add a demand-side angle or its depressing effects to existing explanations. Household deleveraging with resultant consumption cutbacks is the new hotspot for policy attention.
What would monetary response to these developments have been if Covid hadn’t struck? Possibly, RBI may have waited to assess sustenance of the upward momentum in household borrowings after April-June 2019; quarterly financial liabilities increased steadily wherefrom to Rs 2.64 trillion in Jan-March 2020, although still below the previous two years corresponding quarter levels. Perhaps the central bank may have waited for next quarter, or April-June 2020, outturn in the absence of Covid.
But then, Covid happened and since March 27, RBI has cut repo rate by 115 basis points in two reviews, the last being the off-cycle 40bps reduction on May 22. Perhaps the central bank responded with more force to arrest the pre-Covid consumption slide, bolster monetary support in more depressed, Covid-plus demand settings. Employment-income conditions have worsened, income uncertainties—speculated cause of pre-Covid decline in borrowings—have alarmingly heightened.
Will a direr outlook from a fresh, sharp shock further compress private consumer demand? The consumption deceleration extends back to more than a year. The current, Covid year will be the fourth consecutive such, and the worst. Next year’s commonly predicted growth of 6-7% (FY22) will still mean a bare average 1% growth in these two years. Even if consumer spending restores somewhat from release of pent-up demand, there’s likelihood of its subsequent fall back because the period of stress will be long enough for households to adjust spending around new, permanently lower incomes, i.e. enduringly.
The adequacy of monetary response so far will be tested ahead by how credit demand of households unfolds. If deleveraging trend resumes or magnifies, RBI may have to consider a deeper interest rate cut in order to restore confidence, prop up consumption expenditure. That’s the only option to manoeuvre uplift because there’s no other stabilisation tool. Although real interest rates are about zero, depending on calculation off the reverse repo or repo rate, it is pertinent that bank loan rates are aligned to the repo and base loan rates remain elevated.
When households shed debt in a deep slowdown that is magnified by an unfortunate pandemic shock, recovering consumer demand—the sole mainstay for India at this point— could take very long without deep policy support. This is the new hotspot for policy attention. Needless to add that without consumer demand visible in the air, business spending will remain dormant too, dampening the context for realisation of structural reforms.
The author is Delhi based economist.
Views are personal