Household debt must ease before it constrains demand in India

GDP growth and poverty reduction in India draw a striking parallel with this, as  our fast-growing economy has shown spectacular success in combating poverty. The government notes the lifting of 171 million people out of extreme poverty as “one of the most remarkable achievements of the past decade." 

In conjunction with the economy’s rapid expansion, this hints at the existence of sizeable domestic demand that can propel growth at a time when external demand is uncertain. Unconstrained domestic demand is key to retaining the growth momentum required for sustained poverty reduction. 

Also Read: Tax relief will help but cannot fix the Achilles Heel of Indian households

Household consumption, an important component of domestic demand, could  come from income earned or borrowings, or a combination of the two. Households borrow to smooth out consumption, but continued borrowings can result in the accumulation of household debt, undermining future consumption and economic growth. 

Recent research demonstrates that a high level of household debt is not only a good predictor of a financial crisis, but also a key determinant of the intensity of a recession likely to ensue. Further, it points to a key role played by household debt servicing costs in predicting the future vulnerability of a country to stress in the banking system. 

Cross-country evidence suggests that debt boosts consumption and GDP growth in the short run, with the bulk of the impact of increased indebtedness passing through the economy in the space of one year. However, the long-run negative effects of debt eventually outweigh its short-term positive effects, with household debt accumulation ultimately proving to be a drag on growth.

Also Read: Debt isn’t the enemy: It offers many Indian households a lifeline

In India, the per capita debt of individual borrowers has grown from ₹3.9 lakh at the end of March 2023 to ₹4.8 lakh as of 31 March 2025. That’s a sharp 23% increase in two years. At the macro level, over the past 10 years, India’s household debt as a proportion of GDP has almost doubled to reach 41%. Though the country’s household debt-to-GDP ratio is lower than it is in most large economies, it reveals some worrying trends.

First, an increasing number of households are taking loans for consumption purposes: that is, to fund their everyday expenses such as shopping and bill payments. These expenses fall under the ‘non-housing retail loans’ category and account for a lion’s share (or 54.9%) of total household debt as of end-March 2025. Estimates also show that in March 2024, typical borrowers spent 25.7% of their disposable income on paying off these loans. Note that loans under this category do not lead to any asset creation.

Second, the share of loans that  create assets and generate income is too low. Housing loans account for 29% of total household debt as of end-March 2025, while agriculture and business loans account for the remaining 16.1%. This points to a build-up of unproductive debt.

Also Read: TCA Anant: A household income survey will be valuable if clarity beats confusion

Third, the first round effects of borrowing are reflecting in savings. The gross saving rate, which was 34% in 2012, has fallen to 30% in 2023-24. Household savings continued their downward trajectory for the third straight year, slipping to 18.1% of GDP in 2023-24. On the other hand, household financial liabilities surged to 6.2% of GDP, nearly doubling over the past decade, reflecting a growing reliance on credit to meet consumption needs. Thus, households are relying on credit to maintain consumption expenditure. 

Economic logic tells us that rising household debt is explained by inadequate income growth. Slower growth of income in relation to consumption needs would result in a mismatch between required and actual levels of consumption. A widening of the gap between the two leads to deprivation. 

There are two ways in which this gap can be narrowed. 

The first is through government transfers in either cash or kind or the provision of minimum days of employment. Most poverty alleviation policies take this route. The second is through the own efforts of households. That is, while the first set of measures provide the basic minimum, borrowings are used to smoothen consumption. 

In India, households taking the second route seem to be growing in number. Between end-March 2021 and end-March 2024, household disposable income grew by only 43%, whereas consumption grew by almost 50%. Households resorted to loans to fill this gap. Over the same period, personal loans by banks and retail credit extended by non-banking financial companies grew by a staggering 70-75%. 

Also Read: UPI is abuzz with debt payments: Keep track of this trend

There have been two recent household consumption expenditure surveys that form the basis for today’s evidence of poverty reduction. The first was conducted from August 2022 to July 2023 and the second from August 2023 to July 2024. The period of these surveys coincides with the period of increased household borrowings. 

As households may have borrowed for consumption to relieve their indigence, in the coming years a larger share of their disposable income would go into loan repayment. Hence, income needs to grow more rapidly. Else, it would affect future consumption and savings, and the economy would face a demand constraint in the medium-term. Mitigating this risk is crucial to counter negative global shocks. 

These are the author’s personal views. 

The author is director, Madras Institute of Development Studies.