Reserve Bank of India (RBI) governor Yaga Venugopal Reddy has been sermonizing from his financial pulpit these days. Reddy, the Indian equivalent of Federal Reserve chairman Ben Bernanke, though with a trifle less independence, has focused on the dangers of the new credit culture. While corporate borrowers can watch out for themselves, he says, individuals are at risk.

“Rapid economic growth, coupled with demographic dynamics, has led to a significant change in consumers’ perceptions in our country,” Reddy said at the Foundation Day meeting of the Bank of India in September. “With a burgeoning middle class and changing lifestyle aspirations, more and more people are resorting to debt to finance their consumption and asset creation. At some stage in some cases, this could potentially lead to excesses, precipitating defaults.”

The RBI has expressed its worry about retail loans earlier. In its latest Trend and Progress of Banking in India, published in November 2005, the central bank agrees that non-performing assets (NPAs) in the retail loan segment are a low 2%. “Nevertheless, in recognition of the inherent risks in high growth of retail credit, particularly the housing and personal loan segment, the Reserve Bank cautioned banks about the need to sharpen their risk assessment techniques so as to guard against any adverse impact on credit quality. As a counter-cyclical measure, risk containment measures were prescribed on housing and consumer loans, and the risk weights in the case of housing loans and consumer credit, including personal loans and credit cards, were increased from 50% to 75% and from 100% to 125%, respectively, in the Mid-term Review of Annual Policy for the year 2004-05. Furthermore, keeping in view the sharp increase in credit to real estate, banks were advised in July 2005 to put in place a Board-approved policy with regard to exposure to the real estate sector and to submit disclosures to the Reserve Bank in separate returns.”

Reddy and the Reserve Bank sit on one side of the opinion spectrum. They think rampant consumerism is bad. On the other side are Reddy’s charges — the banks and the financial institutions. They believe that retail lending is the way to go. “The RBI is being ultra cautious,” says the CEO of a nationalized bank. “But, then, it has to be. That is what people expect from the central bank. Reddy is only doing his job. But for us in the banking sector, retail is clearly the driver.”

Limited Options for Banks

The reasons are manifold. First, Indian interest rates are higher than those prevailing abroad. Corporate India can go in for external commercial borrowings, now that booming foreign exchange reserves (around $166 billion in October, including gold and Special Drawing Rights with the International Monetary Fund) have allowed restrictions to be lifted. Second, banks are reluctant to increase their exposure to the corporate sector, which is responsible for most of the NPAs that have crippled some of them.

For developmental financial institutions like ICICI, there was no alternative. Their model was to source loans from the government and multilateral agencies at low rates. This was then lent to corporate borrowers and ICICI made money on the spread. With liberalization, the cheap money tap was turned off. ICICI, which converted itself into a bank through a reverse merger with its subsidiary ICICI Bank, had little choice but to go retail. Today, ICICI Bank is the leader in most retail categories. “We have more than a million customers in each of the prominent loan products — cards, personal loans, home loans etc,” says Chanda Kochhar, deputy managing director of ICICI Bank, who has just made it to the Fortune list of the 50 most powerful businesswomen in the world.

According to a report by Mumbai-based equity research and stock brokerage firm SSKI India, ICICI Bank’s retail loans as a percentage of its total loan book is a high 63%. Such numbers are also reflected by the new private sector banks. Centurion Bank of Punjab chalks up 71.6% and HDFC Bank 59.6%. (These numbers are from March 2006.)

The Growth Story

SSKI research also shows why retail is attracting so much attention. According to its projections, mortgage disbursements will rise from Rs 600 billion in financial year 2005 to Rs 1,275 billion in financial year 2009, a compounded annual growth rate (CAGR) of 20.7%. The CAGR it projects over the same period for other categories are: car finance (Rs 260 billion to Rs 477 billion; 16.4%), two-wheeler finance (115-272; 23.9%), consumer durables (40-66; 13.5%), personal loans (125-480; 40%), and credit cards (84-262; 33%). “We estimate a 22% CAGR in retail lending over financial years 2005 to 2009,” says SSKI.

“The share of consumer loans is 10% of GDP (gross domestic product) in India,” says Rana Kapoor, managing director and CEO of the new generation Yes Bank, India’s youngest bank. “With a population of 1.11 billion, the potential is huge.” (In most developed countries, the share of consumer loans to GDP is as much as 100%.) Yes Bank also has major retail plans, but will be operating in niches.

“The Indian market in 2006 is still an under-penetrated market in terms of financial products,” adds Kochhar. “Plastic money accounts for less than 2% of total spending and loan products like home loans are showing double digit growth. Additionally, the rural sector has a large untapped potential.”

All this gung-ho growth and optimism about the future would not have been possible even a decade earlier. The benefits of liberalization kicked in only in the mid-1990s. “Before that, it was the sacrifice generation,” says a sociologist. “You had to queue up for bread; you had a six-month waiting list to buy a TV set. People saved. They had one objective in mind — their children should be better off than themselves.”

The Now Generation

Today, it’s the turn of the Now Generation. Young people are not particularly anxious about their children’s future; they are confident the next generation will be able to take care of itself in a world full of new opportunities. They want to live life to the fullest now. And they are prepared to borrow against future earnings to do so. “Earlier, there was a social stigma attached to borrowing. You had 10 people looking at you,” says SBI (State Bank of India) Cards CEO Roopam Asthana. “Today you get a loan on the phone.”

Where did that social stigma originate? According to Jagmohan Raju, a Wharton marketing professor who has worked on a project about Indian consumer finance with students at the Indian School of Business, its roots lie in India’s traditional rural economy. “Rural interest rates were very high, and farmers associated debt with the risk that you could go out of business unless it rained. Most of the borrowing was for working capital — farmers borrowed to buy seeds, fertilizers and so on. Meanwhile, your income and ability to repay your loans depended on the rains. If you defaulted, you could lose your land.” That high degree of risk and uncertainty, says Raju, led to the social stigma against taking on debt. It made the Indian middle-classes highly debt averse.

That is no longer so. Consumer attitudes have changed because of several other factors. Television and other media have opened the eyes of Indians to what’s available. Earlier, it was urban Indians looking at London and Paris. Today, it’s rural India eyeing Delhi and Mumbai.

“The rural market comprises 41% of the country’s middle class and 58% of its disposable income,” says Soundra Kumar, SBI general manager in charge of personal banking. “Disposable surplus (amongst the consumer class) is higher in rural India as the cost of living is much lower compared to other centers. But the aspirations for a better lifestyle and comfort needs are more or less the same. There is huge untapped potential, and retail growth in the future will come from this segment.”

A Matter of Choice

The growth so far has been more urban, of course. Globalization has played its part here, with the customer getting more choices. Once there was just an Ambassador and a Maruti. Today, you can see practically every make of car on Indian roads. The imperatives of liberalization forced the government to both free imports and allow global auto majors to set up shop here. That’s true across categories. Says Asthana: “Globalization has had a huge impact. Today there is a lure to buying luxury items.”

There is more local choice, too. “The competitiveness, productivity and technological capabilities of Indian industries also increased post reforms and this translated into new and evolved products launched in the Indian market,” says Kochhar.

All this would not have taken place if there had not been two key changes — one tangible and one intangible. The first lies in the growth of a young, well-paid workforce. The IT (information technology) services sector may have started it all. Now it’s everywhere — from new arenas like knowledge process outsourcing and retail, to the old mainstay — manufacturing. In the mid-1980s, a graduate from the Indian Institute of Management (IIM) Bangalore was happy to get a starting salary of Rs 50,000 a year. Earlier this year, Gaurav Agarwal was snapped up by Barclays Capital for $193,000 (about Rs 8,600,000).

That may be an extreme example. But there have been increases across the board. According to Ajay Kelkar, head (marketing) at HDFC Bank, “the demographics are changing. So many more young consumers have money to spend.” ICICI Bank’s Kochhar notes that “with the growth in IT, ITES (IT enabled-services), BPO (business process outsourcing) and other services sectors in India, this segment is getting better job opportunities and has a higher disposable income. Today they form an important portion of the Indian market in all spheres of business.”

Growing Confidence

The other change — the intangible — is partly the result of the first. India, and not just young India, is a more confident country today. “Indian consumers are still on top of the world,” says the headline news from international marketing information provider ACNielsen. According to its survey in September 2006, India leads the Global Consumer Confidence Index with a score of 131. The country has done that for three surveys in a row. The global average was 98. According to Kumar of SBI, “The younger generation is confident about the future and is willing to borrow, as against the previous generation which was averse to taking loans.” Wharton’s Raju agrees. “The confidence stems not just from the fact that people are earning high incomes today, but also that they expect to make more money in the future.”

There are still some people on a guilt trip, but the overall confidence is also shared by the purveyors of retail products. According to Kochhar, “The growth in consumerism is riding on a strong infrastructure, agricultural and industrial growth base, compared to growth in other countries where the growth was only in the financial sector without appropriate growth in core sectors. The other positive factor is that the reforms in the Indian economy have been steady, and proper checks and balances have been put into place to avoid runaway growth.

“The combination of the availability of new and evolved products, higher disposable income, the consumer’s needs, the desire to obtain an even better standard of living and access to various financing options has led to a paradigm shift in the attitude of consumers for debt.”

Kochhar says India is unique; you cannot artificially impose the lessons from some other country on the subcontinent. “There does not seem to be a trend of the Indian economy following a pattern of other countries,” she says. Kapoor of Yes Bank adds: “Although the financial intermediaries have managed to make inroads into the urban segment, the semi-urban and rural segments are yet to be tapped. To that extent, India’s consumption behavior is likely to remain unique for some time.” Kumar of SBI says that unlike the world over, India’s GDP growth of more than 8% in the last financial year and the expansion of the economy are resulting in a different pattern from other countries in the retail segment. “The economy is experiencing phenomenal growth,” she says.

Marketing Hype?

Is this an artificial world that marketing has created? Has consumerism become respectable only because of the dream merchants of advertising? Has there been too much hard sell? Not at all, says Kapoor. “Marketing has managed to sell the concept that one should indulge in purchasing goods today, as tomorrow’s increased income will take care of tomorrow’s needs. A booming economy and an overall feel-good factor have definitely given momentum to this phenomenon.” But he agrees that marketing has influenced the new generation by introducing a host of innovative products that were earlier unknown to the average Indian. “A low EMI (equated monthly installment), thanks to well-packaged schemes, coupled with the low interest range regime enables one to indulge in a car by the age of 23 or a house by the age of 28 or 30.”

Wharton’s Raju points out that confidence as well as consumption are fuelled by one additional factor — the realization that many of the purchases of middle-class Indians actually increase productivity. “Buying a motor cycle reduces your commuting time on public transportation. A washing machine or a microwave oven can help working families, especially working women, cut down on household chores and cooking times. Debt taken on for such purchases can make people more productive. That shows up in their output and eventually in their incomes.” Data show that most of the debt that Indian consumers are taking on is for productivity-boosting durable products rather than for consumption or entertainment, Raju adds.

The sacrifice generation managed to acquire a car only after age 40. A house was even later — 45 and even 50. When installments had to be paid even after retirement, saving was inevitably the first priority.

Saving was the first priority for the 70-year-old Madhukar Sathe, who lives a few blocks away from RBI governor Reddy. He hasn’t ever met or seen him. But he can probably concur with his thinking. His son Sailesh has just returned from a holiday in China. “I told him he shouldn’t waste money on frivolous holidays,” says Sathe Sr. “We would never have done it. Because I was so frugal, I managed to pay for this house.” He didn’t rely on any loans except for some help from his company.

Sathe Jr. brought back some chocolates. He did not tell his father how much they cost. It would have turned to ashes in his mouth. The box probably cost the equivalent of one month’s salary in his father’s prime. Sathe Jr is trying to buy him a hearing aid because the old man is practically deaf. It costs just Rs 5,000, the sort of money the young man makes in a day. His father will have none of it. “We were taught not to waste money,” he says. “I can still watch TV. There is nothing wrong with my eyes.” They live together in two different worlds, each with his own views about life and debt.