The NABARD All India Rural Financial Inclusion Survey (NAFIS) report provides a holistic understanding of the extent and nature of engagement that rural households have with formal financial services and the role of financial inclusion in the household’s well-being. This blog presents key insights from the second round of the survey report, NAFIS 2021-22, and finds that the rural households’ investment portfolio continues to be dominated by physical assets, which is in contrast with the predominance of formal debt on the liabilities side of the household balance sheets. When faced with financial uncertainty, households employ an intuitive model of decision-making that combines both formal and informal sources of savings and borrowings to smooth their consumption. Finally, the report suggests that high dependence on borrowing among rural households combined with a low ability to repay could be associated with conditions of over-indebtedness and financial distress.
Household Context
Growth of household monthly income fell short of the rise in expenditure between 2016-17 and 2021-22, indicating a potential strain on their financial resources and erosion of purchasing power. A comparison between NAFIS 2016-17[1] and 2021-22 reveals that while income had grown by 28 percent, expenditure increased by a much higher rate of 38 percent.
In 2021-22, 69 percent of households were documented to be engaging in two or more employment activities in an attempt to diversify their income streams, with the average monthly household income working out to be ₹12,698. This includes self-employment, government or private sector services, cultivation, and casual wage labour.
Rural households have developed an intuitive model of financial decision-making that involves investing in a range of physical and financial assets while simultaneously leveraging their established social networks to help them navigate financial uncertainties.
Household Investments
The survey finds that investments in physical assets, such as real estate and gold, continue to dominate the household portfolio. The average investment reported in 2021-22 suggests that 87 percent of the households’ portfolio is comprised of physical assets, and the remaining 13 percent is invested in financial assets. This is an increase from a 73 percent allocation in physical assets and a decrease from 27 percent in financial assets in 2016-17. However, the absolute value of the average annual investment in physical assets decreased from ₹56,382 in 2016-17 to ₹ 41,117 in 2021-22. The average investment in financial assets stood at a measly ₹ 5,994 in 2021-22, registering a significant reduction from ₹21,348 in 2016-17. A potential explanation could be the reference period for the survey which spans from July 2021 to June 2022, which falls right after the second wave of the COVID-19 pandemic in India and overlaps with the third wave of the outbreak between January and February 2022.
Land ownership occupies a special place among physical assets in the rural household portfolio. It is not only a key input for agriculture but also enables access to and utilization of other financial and non-financial resources. The average size of land owned by rural households is reported to be 0.42 hectares.
When uncertainty strikes, households experiencing distress choose to rely on personal savings and debt for consumption smoothing. A significant 58 percent of all households reported that at least one of their members had saved any money in an institution in the agricultural year 2021-22. Among these households, 77 percent saved their money in banks, including scheduled commercial banks, regional rural banks, and cooperative banks. Another 18 percent of households reportedly saved their money at home. It is primarily home savings, in the form of stored liquidity that is planned for usage during times of uncertainties and, less obviously, for nurturing social and business relationships by lending to others in their community.
Household Indebtedness
The survey reports that about 42 percent of households had opted for loans in the given reference period. Among those households who took loans, 97 percent had taken only a single loan in this period. Borrowing to meet domestic needs stood out as the single most popular use case for 29 percent of households in the survey. This brings to focus how debt is used as a vital strategy for managing finances by rural households.
87 percent of the total value of household borrowings are from institutional sources, while the remaining 13 percent are from non-institutional sources. This contrast between formal debt on one hand and non-financial physical assets on the other suggests that financial inclusion in India has largely been a credit-led story. Access to suitable non-credit products remains an important gap in Indian household’s financial portfolios.
Among institutional sources, 75 percent of households reported borrowing from scheduled commercial banks, bank-linked SHGs/JLGs, and NBFCs in 2021-22, as opposed to 58 percent in 2016-17. Among those taking loans from non-institutional sources, 23 percent of households reported taking loans from relatives or friends, an allocation which remains close to the 25 percent observed in 2016-17. Less than 2 percent of households opted for loans from money lenders, landlords, traders, etc., which is a significant reduction from 11 percent as per NAFIS 2016-17.
Excess household debt can lead to increased financial burden, risk of default, and severe psychological stress. We calculate the Debt Service Capacity Ratio (DSR) to understand the degree of over-indebtedness experienced by rural households. It is calculated as the ratio of households’ average annual indebtedness[2] to average annual disposable income[3]. Both in 2016-17 and 2021-22, DSR is 2.7 times the annual disposable income. This could be indicative of unsustainable levels of debt burden and over-indebtedness among rural households.
Recommendations
The NAFIS dataset presents a rich repository of information on the financial lives of rural households in India. NABARD should consider making this data publicly available for further analysis, which will allow for a much richer discourse on the topic. Empirical methods can be applied to the dataset to answer various questions of interest, such as the relationship between financial inclusion and well-being, predictors of financial inclusion at an individual and household level, etc. The dataset can also be used to construct a demand-side financial inclusion index, which could act as a good companion to the supply-side index facilitated by the RBI annually. The demand-side financial inclusion index can be disaggregated by region, household type, and other parameters to build a granular understanding of the state of financial inclusion in rural India.
[1] All values from NAFIS 2016-17 have been expressed in 2021-22 terms using an inflation factor.
[2] The value of the households’ average annual indebtedness is based on all households in the sample. If it is taken as the value for only indebted households, the DSR increases to 63 times in both 2021-22 & 2016-17.
[3] In our previous work on calculating over-indebtedness, we proposed the use of DSR as the ratio of average disposable income to the repayment obligation of the borrower. Irrespective of how the ratio is computed, the inference about the serviceability of debt remains unchanged.
The second part of this blog is available here.
