Why RBI is unlikely to cut interest rates later this month

RBI-Logo_8Vivek Kaul  
The business lobbyists want the Reserve Bank of India (RBI) to cut interest rates, now that the inflation for December 2013 has come down. “The easing of inflation at a time when industrial growth continues to be in the red should induce RBI to review its monetary policy stance and cut policy rates to rejuvenate growth, which has been hit by high interest costs, flagging investments and subdued demand,” Chandrajit Banerjee, the director general of CII said. Similar statements were made by other business lobbies as well.
There are multiple issues that need to be discussed here. Lets start with the inflation. The consumer price inflation(CPI) fell to 9.87% from 11.16% in November 2013. The wholesale price inflation(WPI) fell to 6.16% from 7.52% in November 2013.
A major reason behind the fall in inflation is the fall in vegetable prices. As per the CPI index, vegetable prices in the month of December 2013 fell by 18.4% in comparison to November 2013. In case of the WPI, the fall was greater at 29.7%. Onion prices fell dramatically by 42.4%.
Nevertheless, the prices of a lot of other food items continue to go up. As per the CPI index, prices of egg, fish and meat have gone up by 12.6% in the last one year. The price of milk products has gone up 9.87%. Cereal prices have gone up by 12.1%. Interestingly, the prices of these food items has gone up in December 2013 in comparison to November 2013. In fact, as per the WPI index the price of rice has gone up by 13.6% in the last one year.
If one looks at the overall category of food products, the prices declined by 0.6%(as per the WPI index) and 2.4%(as per the CPI index) between November and December 2013. Given this overall food prices continue to remain high. Also, if one takes the food and fuel prices out of the equation, the core consumer price inflation (CPI) in December 2013 was at 8%.
It is widely believed now that Raghuram Rajan, the governor of the RBI, is looking more at the CPI number while making policy decisions. 
As he had said in a statement dated September 20, 2013 “What is equally worrisome is that inflation at the retail level, measured by the CPI, has been high for a number of years, entrenching inflation expectations at elevated levels and eroding consumer and business confidence.”
Despite vegetable prices falling, the CPI number continues to remain on the higher side. If Rajan and the RBI continue to focus on the CPI number, it is unlikely that they will cut the repo rate any time soon. Repo rate is the rate at which the RBI lends to banks.
Even on the WPI front things don’t look too optimistic. Economists expect vegetable prices to continue to fall. But even with that they expect inflation to start rising again given that the prices of food items like rice are rising.
As Sonal Varma of Nomura Securities put it in a research note dated January 15, 2014, “Going forward, the correction in vegetable prices is still incomplete and should continue. However, with prices of other food items rising (such as rice) and base effects turning adverse, the expected fall in WPI in January-February should reverse again after March.”
As far as the industry lobbies are concerned they want the RBI to cut interest rates in order to revive industrial growth. The index of industrial production (IIP), a measure of industrial activity in the country, fell by 2.1% during the month of November 2013. The low industrial growth is also reflected in manufacturing inflation, which forms around 65% of the WPI index, and grew by a minuscule 2.6% in December 2013, in comparison to December 2012. In December 2012, the manufacturing inflation was at 5.04%.
What these low numbers tell us is the lack of consumer demand. People have been handling double digit consumer price inflation over the last few years. At the same time their incomes haven’t been able to keep pace with the rate of inflation. Food inflation has been been particularly high. A higher inflation also leads to the regular expenditure of people, as a proportion of income going up. Given this, they have had to cut down on expenditure on non essential items like consumer durables, cars etc, in order to ensure that they have enough money in their pockets to pay for food and other essentials.
This is reflected in the index of industrial production when seen from the use based point of view. The index number of consumer durables fell by 21.5% in comparison to November 2012. The index number of consumer goods, which has the highest weightage in the index, fell by 8.7%, in comparison to the same period last year. When the demand for goods is falling, it is but natural that there production will fall as well.
Hence, high consumer price inflation has been killing consumer demand. There is not much the RBI can do to control it, given that a major part of it is driven by a rise in food prices. At the same time, it won’t want to take the risk cutting interest rates, hopefully pushing up consumer demand and manufacturing inflation in the process. This will push up inflation further, and in the process build in more inflationary expectations into the system.
Also, it is worth remembering that the repo rate is at best an indicative rate. Even if the RBI were to cut the repo rate, it remains up to the banks whether they are in a position to pass on the rate cut to their consumers. The loan to deposit ratio of Indian banks as on December 27, 2013, stood at 75.2%. This means that banks have given out loans worth Rs 75 for every Rs 100 they had raised as deposits.
This ratio is on the higher side given that banks need to maintain a statutory liquidity ratio of 23% i.e. for every Rs 100 raised as a deposit they need to buy government bonds worth Rs 23. They also need to maintain a cash reserve ratio of 4% i.e. for every Rs 100 raised as a deposit they need to maintain Rs 4 with the RBI. Once this is factored in, the credit deposit ratio should not go beyond 73%. What this tells us is that banks have been borrowing from other sources at higher interest rates (in comparison to what they pay for deposits) to give out loans. In this scenario, the ability of banks to cut interest rates is rather limited.
Given these reasons, it is unlikely that the RBI will cut interest rates when it meets later this month on January 28, for the third-quarter review of monetary policy.
The article originally appeared on www.firstpost.com on January 17,2014

(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Sensex reclaims 21k: Why yen carry trade will ensure ‘easy money’ continues

1000-yen-natsume-sosekiVivek Kaul
The Federal Reserve of United States, the American central bank, plans to go slow on money printing starting this month i.e. January 2014. Until the last month the Federal Reserve printed $85 billion every month. It pumped this money into the financial system by buying government bonds and mortgage backed securities.
The idea was to ensure that there is enough money going around in the financial system and, thus, help keep long term interest rates low. This would hopefully encourage people to borrow and spend and, thus, help the American economy to start growing again.
The risk was that all the money being printed would lead to inflation. While the money printing hasn’t led to consumer price inflation, it has led to a rapid rise in the stock market as well as real estate prices in the United States. This is primarily because people (which includes investors) could borrow at very low interest rates and invest that money in stocks as well as buy homes.
“Since the turnaround began on March 9th, 2009, the S&P-500 index has chalked up gains of +175%, – ranking it as the fourth longest bull market of all-time. In cash terms, the US-stock market has generated $13.5-trillion in paper wealth,”
writes Gary Dorsch, Editor, Global Money Trends, in his recent column.
The 20 City S&P/ Case- Shiller Home Price Index, the leading measure of U.S. home prices,
rose by 13.6% in October 2013, in comparison to a year earlier. This is the highest gain in prices since February 2006, when prices had risen by 13.9% in comparison to the year earlier. Real estate prices in the United States, as measured by the 20 City S&P/Case- Shiller Home Price Index had peaked in April 2006.
So the markets in the United States as well as other parts of the world have done very well over the last few years as the Federal Reserve of United States has printed truck loads of money. The interesting thing is that even with the Federal Reserve deciding to go slow on money printing, the markets haven’t fallen.
It is worth pointing out here that when the Federal Reserve Chairman Ben Bernanke had first talked about going slow on money printing (or tapering as he called it) in May-June 2013, financial markets (stock, bond and foreign exchange) had reacted very badly to the news.
But when the Federal Reserve has actually gone ahead with “tapering” and decided to print $75 billion per month (instead of the earlier $85 billion) the markets haven’t reacted violently at all. Why is that the case?
One reason is the fact that the Federal Reserve has managed to communicate to the investors that tapering isn’t really tightening. What that means is that even though the Federal Reserve will go slow on money printing and not print as many dollars as it was in the past, it will ensure that short term interest rates will continue to remain low.
As Jon Hilsenrath writes in the Wall Street Journal “Most notably, the Fed’s message is sinking in that a wind down of the program won’t mean it’s in a hurry to raise short-term interest rates.”
This means at some level the dollar carry trade can continue. Hence, big institutional investors can continue to borrow in dollars at low interest rates and invest that money in different financial markets all over the world.
It needs to be pointed out that whether the Federal Reserve decides to further cut down on money printing depends on the overall state of the American economy. One particular number that the Federal Reserve likes to look at is the number of jobs created every month. In December 2013, the US economy saw a net increase of 74,000 jobs.
As Andre Damon writes onwww.globalresearch.ca “The US economy generated a net increase of only 74,000 jobs in December, about one third the number predicted by economists and less than half the amount needed to keep pace with population growth. The increase in non-farm payrolls was the lowest since January 1, 2011, when the economy added 69,000 jobs. Friday’s number followed two months in which payrolls grew by 200,000 or more, leading to claims that the economy was shifting into high gear.” This implies that it will be difficult for the Federal Reserve to cut down from the $75 billion that it is currently printing in a month. Hence, it is unlikely that the Federal Reserve will stop money printing any time soon.
What has further energised the financial markets is the fact that the Bank of Japan, the Japanese central bank, is also printing money big time. As Dorsch writes “The Bank of Japan(BoJ) has taken a page out of the Fed’s quantitative easing playbook, – but multiplied by 3-times. The BoJ is buying ¥7.5-trillion of government bonds (JGB’s) per month, and intervening directly in the equity market, by purchasing ¥1 trillion of exchange-traded funds linked to the Nikkei-225 each year. The BoJ aims to inject $1.4-trillion into the Tokyo money markets by April ‘15, equal to a third of the size of Japan’s $5-trillion economy.”
The Federal Reserve until last month was printing $85 billion every month. This works out to a around $1.02 trillion every year. The amount of money being printed by the Bank of Japan is more than that. What this means is that interest rates in Japan will remain low. This will encourage the yen carry trade, where an investor can borrow in yen and invest the money in different financial markets around the world.
What will also help is the fact as the Japanese central bank keeps printing money, the yen will depreciate against the dollar and thus spruce up returns. In the last one year the yen has gone from around 89 to a dollar to almost 103-104 to the dollar currently. “With liquidity injections of ¥7-trillion per month, Tokyo has engineered the yen’s -18% devaluation against the US$, -23% against the Euro, -15% against the Korean won, and a -12% slide against the Chinese yuan,” writes Dorsch.
How does this help yen carry trade? Let us understand this through an example. Let’s say an investor borrows 100 million yen and converts them into dollars. Currently one dollar is worth around 104 yen.
Hence, 100 million yen can be converted into around $961,538 (100 million yen/104). This money is invested in financial markets around the world and let’s say at the end of one year has grown by around 8% and is now worth $1.04 million. One dollar by then let us assume is worth 110 yen.
When $1.04 million is converted into yen, the investor gets 114 million yen. This means a return of 14%. Hence, the depreciating yen adds to the overall return for anyone who borrows in dollars.
It also means that financial markets around the world will see foreign investors continuing to bring in more money. India should also benefit from the same over the next one year. Given this, the BSE Sensex should continue to go up till December 2014. CLSA expects the Sensex to touch 23,500 by December 2014. Deutsche Bank Markets Research expects the Sensex to do even better and touch 24,000 by the end of this year. It does not matter that the real economy will continue to be in doldrums.

The article originally appeared on www.firstpost.com on January 13, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)


What Aam Aadmi Party can learn from BJP

Arvind-Kejriwal3 Vivek Kaul
Noted lawyer and senior Aam Aadmi Party leader Prashant Bhushan has come in for severe criticism for his recent remarks on Kashmir. Bhushan had told Aaj Tak and Headlines Today that “People should be asked whether they want the Army to handle the internal security of Kashmir… If people… say they don’t want the Army to be deployed for their security then the Army should be withdrawn from the hinterland.”
The statement basically brought back the age old issue of having a plebiscite to decide what the people of Kashmir really want. Plebiscite is essentially a direct vote in which people are asked to either accept or reject a proposal.
It needs to be pointed out that this is not the first time that Bhushan has talked about having a plebiscite in Kashmir. On September 26, 2011, 
while addressing a press conference in Varanasi, Bhushan had said “It is my personal opinion that no country or part of its territory can be governed without the wishes of the people with the help of army. This is not in the interest of the country and the people…I want that the situation be normalized, Army be withdrawn, the Armed Forces Special Powers Act be also withdrawn and then try to persuade the people of Kashmir to stay with India. And yet, if the people want, then there could be a plebiscite, and if the people of the Valley want separation, they be allowed to separate.” On October 12, 2011, Bhushan was attacked and beaten up because of this statement, by youth claiming to be from the Bhagat Singh Kranti Sena.
The situation has changed a lot since then. In 2011, Bhushan was a lawyer who had a remarkable role to play in exposing various scams, but now he is a senior leader of the Aam Aadmi Party. The party after having made a stupendous debut in the Delhi state assembly elections now has national aspirations. And a senior leader of a political party seeking national presence cannot be seen to have such a view on Kashmir—a view which questions the idea of a united India.
As Pratap Bhanu Mehta writes in 
The Burden of Democracy “Groups may have deep seated grievances and suppressed complexes but the mere freedom to articulate them gives them a stake in the system like nothing else. And the imperatives of seeking sustainable majorities, most observers argue, moderates even the most radical movements, giving them a largely centrist cast.”
Bhushan and the Aam Aadmi Party need to keep this in mind if they want to move from being a local political party in Delhi to being a national level political party. Bhushan’s view on Kashmir might at best appeal to a section of the population in Kashmir and a few people among the intellectual class. Radicalism of the sort he espouses on Kashmir won’t help the Aam Aadmi Party. This is not to say that Bhushan should not have the views on Kashmir that he has. Its just that politically neither he nor the Aam Aadmi Party can afford to have these views.
In fact, Bhushan and the Aam Aadmi Party can learn a thing or two from the Bhartiya Janata Party (BJP) here. In 1996, the BJP formed a government which lasted for a mere 13 days. It then realized that if it had to ever come around to governing the country, it would have to keep its certain ‘core’ issues on the back burner. A centrist position would be more beneficial politically was the realization that the party had. As Ashutosh Varshney writes in 
Battles Half Won—India’s Improbable Democracy “In 1998, the BJP managed to assemble a broad alliance of parties and come to power, but only after dropping key Hindu nationalist demands, such as the construction of a new temple on the site of the razed Ayodhya mosque; the adoption of a common civil code to supersede all the ‘personal laws’ of the religious minorities; the termination of the special status of Jammu and Kashmir (India’s only Muslim-majority state). India’s pluralism has induced the BJP to scale back its anti Muslim rhetoric; to build coalitions across caste, tribal, linguistic, and religious lines; and to seek alliances with regional parties in states where Hindu nationalist ideology makes no sense.” In fact, the party has gone ‘soft’ on these issues since then and is seen talking more about economic and social progress.
Other than Bhushan, Kumar Vishwas, another senior leader of the Aam Aadmi Party, has also come in for a lot of criticism, for his politically incorrect views on issues as wide ranging as women to Muharram.
Vishwas is a Hindi poet who primarily writes poems about love and romance(his most famous poem is 
koi deewana kehta hai). Given this, he has a huge popularity among students and over the last decade has been seen regularly at college festivals around the country. The colleges tend to have more males students than female students, and in this environment, it is not surprising that Kumar has made some quips about women which are now being seen as politically incorrect, though at the point he said them, students had laughed at it.
While Kumar cannot erase things he has already said, but as a leader who hopes to take on Rahul Gandhi in the next Lok Sabha elections, things that he says in the public domain in the days to come need to be politically correct and hold a centrist view on most issues. And the same holds true for the other leaders of the Aam Aadmi Party as well.
As it expands rapidly in the days to come, the Aam Aadmi Party will make its set of mistakes. Other political parties are all waiting to latch on these mistakes and turn them into “issues” they can cash in on. Given this, it is important that the leaders of the Aam Aadmi Party do not score any more self-goals.

 The article originally appeared on www.firstpost.com on January 9, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Why believing that real estate prices will never fall is a stupid idea

India-Real-Estate-MarketVivek Kaul

In a piece I wrote yesterday I said that banks in India play an important role in ensuring that real estate prices do not fall. The main point was that loans given by banks to commercial real estate, between November 2012 and November 2013, has grown at a much faster rate than their overall lending.
This has happened in an environment where real estate companies have a lot of unsold homes(or what is referred to as inventory in technical terms). The number of new projects being launched by real estate companies has also fallen significantly.
Hence, fresh loans given by banks has helped real estate companies pay off their old loans. And this has ensured that they haven’t had to cut prices in order to sell their unsold inventory. If bank loans to commercial real estate hadn’t grown as fast as it has, then
the real estate companies would have had to sell off their existing inventory to repay their bank loans. And in order to do that they would have to cut prices.
In response to this piece several readers said that real estate prices never fall. Still others agreed that there is a real estate bubble in India but that bubble would never burst (whatever that meant). And this is not the first time I have received such responses.
So what is it that leads people to believe that real estate prices never fall? People have seen real estate prices only go up over the last 10 years. A home that was bought for Rs 25 lakh is now worth Rs 2 crore. Hence, there is a firm belief that real estate prices can only keep going up.
In fact such confidence was observed even during the American real estate bubble that ran from the late 1990s to late 2006.
As Alan S. Blinder writes in
After the Music Stopped “A survey of San Francisco homebuyers… found that the average price increase expected over the next decade was 14 percent per annum…The Economist reported a survey of Los Angeles homebuyers who expected gains of 22 percent per annum over the same time span.”
At an average price increase of 14% per year, a home that cost $500,000 in 2005 would have cost $1.85 million by 2015. At 22% it would have cost $3.65 million.
If we apply this in an Indian context we get some fairly interesting numbers. A three bedroom apartment near the Sector 12 metro station in Dwarka, a sub-city of Delhi, went for around Rs 25 lakh nearly 10 years back.
Now it costs around Rs 2 crore. If prices rise at 14% per year it will cost Rs 7.4 crore in 10 year’s time. At 22% it will cost Rs 14.6 crore. If prices rise at the same rate as they have in the last ten years, then the home would cost around Rs 16 crore. And these are huge numbers that we are talking about here. This small calculation tells us how ridiculous it is to assume that real estate prices will continue to go up at the same rate as they have in the past.
We all know what happened in the United States. The real estate bubble peaked in 2006. Prices started to fall after the last. For the last 16 months real estate prices as measured by the
20 City S&P/ Case- Shiller Home Price Index, have been rising. But they are still 20.7% below their 2006 peak.
A similar thing is playing out in the Indian context as well, wherein people are extrapolating the price rise of the last 10 years over the future. They are “anchored” into the price rise that real estate has seen over the last 10 years and this has led them to believe that prices will continue to rise forever.
What they forget is that real estate prices fell dramatically between 1997 and 2003. As
Manish Bhandari of Vallum Capital writes in a report titled The End game of speculation in Indian Real Estate has begun “The previous deleveraging cycle in year 1997-2003 witnessed price correction by more than 50% in Mumbai Metro Region (MMR) property.” Yes, you read it write, prices fell by 50% in Mumbai, the last place you expect prices to fall, given that the city is surrounded by the sea on three sides and can grow only in one direction.
Other than the price rise, another reason behind the belief that real estate prices will continue to go up is the fact that there is only so much land going around. In fact, this reason has been offered for more than 100 years.
George A. Akerlof and Robert J. Shiller point out in Animal Spirits “In a computer search of old newspapers, we found a newspaper articles from 1887—published during the real estate boom in some U.S. cities including New York—which used the idea to justify the boom amid a rising chorus of skeptics: “With the increase in population, the demand for land increases. As land cannot be stretched within a given area, only two ways remain to meet demands. One way is to build high in the air; the other is to raise price of land…Because it it perfectly plain to everyone that land must always be valuable, this form of investment has become permanently strong and popular.”
The point I am trying to make here is that the ‘limited land’ argument to justify high real estate prices is as old as land being bought and sold. Nevertheless, in most cases there is enough land going around. This is reflected in the American context in the fact that real estate prices have barely risen over the last 100 years, once they are adjusted for inflation.
As Akerlof and Shiller write “Moreover, real home prices in the United States rose only by 24% from 1900 to 2000, or 0.2% per year. Apparently land hasn’t been the constraint on home construction. So home prices have had negligible real appreciation from the source.”
What about India? While land maybe an issue in a city like Mumbai, it clearly is not much of an issue anywhere else. There is enough land going around.
Economist Ajay Shah
did some number crunching in a May 2013 column in The Economic Times. He showed that there is enough land to house India’s huge population. As he wrote “A little arithmetic shows this is not the case. If you place 1.2 billion people in four-person homes of 1000 square feet each, and two workers of the family into office/factory space of 400 square feet, this requires roughly 1% of India’s land area assuming an FSI(floor space index) of 1. There is absolutely no shortage of land to house the great Indian population.”
Also, it is worth pointing out here that real estate prices have fallen dramatically even in countries like Japan where land unlike the United States is scarce. “
Urban land prices have recently fallen in Japan (where land is every bit as scarce as it is in other countries). In fact they fell 68% in real terms in major Japanese cities from 1991 to 2006,” write Akerlof and Shiller. And the property prices in Japan are still lower than they were in the 1980s.
The moral of the story is that just because something has continued to happen till now, does not mean that it will continue to happen in the future as well. There are many fundamental reasons behind why the Indian real estate bubble is unsustainable (
I made some of them in yesterday’s piece).
Let me make a few more here. Indian real estate has now become totally unaffordable. As Bhandari writes “
The current real estate price represents affordability of very few, while average users have to sell their twenty years of future earnings to afford a house.”
The employment situation remains extremely grim. In a report titled
Hire and Lower – Slowdown compounds India’s job-creation challenge,Crisil estimates that “employment outside agriculture will increase by only 38 million between 2011-12 and 2018-19 compared with 52 million between 2004-05 and 2011-12.” This in an environment where “India’s working age population would have swelled by over 85 million. Of these, 51 million would be seeking employment.”
With fewer non agriculture jobs being created a direct implication would be that incomes will not continue to grow at the same pace as they have in the past. And that in turn will mean a lower amount of money waiting to get into real estate. There are other economic indicators also which clearly show that the Indian economy has slowed down considerably than in comparison to the past. And the real estate sector will have to adjust to this reality.
Bhandari believes that the scenario that played out during the period 1997 ad 2003 will play out again, very soon. As he points out “
One of the most important proponents of fall in the property prices is likely to start from the deleveraging cycle, by the Indian banking sector, which is running a multi decade investment to deposit ratio (108%). The reversal of easy business cycle, scarcity of capital, tight monetary cycle in domestic and international market will force scheduled commercial banks to deleverage their balance sheet over the next three to four years. One can observe the same scenario, witnessed in 1997-2003, when deleveraging by the Indian Banking Sector was accompanied by deleveraging corporates that had accumulated huge debts on their books during good times. This augurs a difficult time for the Real Estate Industry.”
ven with all these reasons it is difficult to predict when the Indian real estate bubble will start running out of steam. But that does not mean that real estate prices will never fall in India. It may happen this year. Or in 2015. Or the year after that.
But in the end, all bubbles burst. It is just a matter of time. As Blinder aptly puts it “Anyway, one thing we
do know about speculative bubbles—whether in houses, stocks, or anything else—is that they eventually burst.” And what that tells us is that days of earning huge returns from Indian real estate are more or less over.
The article originally appeared on www.firstpost.com on January 8, 2014

(Vivek Kaul is a writer. He tweets @kaul_vivek) 

How banks help keep real estate prices high

 India-Real-Estate-MarketVivek Kaul
 John Maynard Keynes, the greatest economist of the twentieth century, once remarked “markets can remain irrational longer than you can remain solvent.” In simple English, one of the interpretations of this statement is that the bubbles can keep running for a very long period of time.
The Indian real estate sector is an excellent example of the same. It has been a bubble for the last few years now, but hasn’t burst.
Before we go any further it is important to define the word ‘bubble’. The 
Financial Times Lexicon defines an asset bubble as follows: “When the prices of securities or other assets rise so sharply and at such a sustained rate that they exceed valuations justified by fundamentals, making a sudden collapse likely – at which point the bubble bursts.”
The problem with this definition is that no one really knows when the bubble will burst. The fundamentals may point out to the fact that the bubble might burst any time soon, but that may or may not happen.
Lets try and understand this in the context of Indian real estate. How good are the fundamentals? It is a well known fact that real estate companies are having a tough time trying to sell homes they have already built up (or what in technical terms is referred to as inventory). As a November 2013 report of Colliers International points out “Pressures of increasing unsold inventory and a liquidity crunch resulted in fewer project launches. There was an increase in the incentives being offered to sell property, such as easy payment plans, discounts and free gifts with bookings.”
So homes in projects that have already been built up are lying unsold. And the number of new projects being launched have come down. As a December 2013 report 
in the Business Standard points out “New property launches in the residential segment across cities declined 12 per cent in the year, with Chennai recording the sharpest drop at 39 per cent, followed by the National Capital Region at 33 per cent and Pune at 20 per cent, according to a report by Cushman & Wakefield. Mumbai recorded just 6 per cent growth in launches.”
What this tells us is that the demand for real estate has slowed down. So, why aren’t prices coming down is the logical question to ask? One reason is the fact that a lot of homes that have already been bought have been bought by investors, who are in no hurry to sell out. Shashank Jain executive director, PwC India explained 
this point in a recent interview to the Daily News and Analysis (DNA). He said that investors are largely of two types—those looking to deploy black money—and senior executives looking to invest in their in a second or third home.
“One, the business community with an element of unaccounted surplus being parked in realty. The government is trying to control them by imposing TDS (tax deducted at source) of 1% on an amount of Rs50 lakh and more. Two, a significant chunk of investment is made by white collar executives, especially in the metro micro markets. This class of investors is putting its surplus income in a second or third home. They don’t have exit pressure. That again means that prices will not come down significantly,” said Jain.
This explains to some extent why real estate prices are not falling. But it does not explain why real estate companies are not cutting prices to get rid of their surplus inventory. It only explains why investors are holding on to homes they have already bought.
It is important to understand that any bubble keeps running till money keeps coming into it. Between 2005 and 2012, a lot of money came into real estate through the private equity route. As Manish Bhandari of Vallum Capital writes in a report titled 
The End game of speculation in Indian Real Estate has begun “Private Equity investments drove in hordes after opening of Foreign Direct Investment (FDI) in real estate sector in the year 2005. The high structural growth story of India attracted a lot of private equity capital the in real estate industry during the Yr 2005-2012, with major inflows coming in the Year 2007-09. Close to $US 20 bn of inflow came to into real estate & construction business, which has put the prices on steroids.”
So, over a period of time, money coming in from the private equity investors has kept real estate prices high. But as Bhandari says private equity inflows peaked during the period 2007 to 2009. There has to be a more recent reason for real estate prices not falling.
The answer lies in some interesting data provided by the Reserve Bank of India (RBI). Between November 30, 2012 and November 29, 2013, the total loans given by banks (excluding food credit) grew by 14.7%. During the same period loans given to commercial real estate grew by a much faster 19.1%. This, in an environment where real estate companies have huge inventories and the launch of new projects has slowed down considerably. So, why are banks lending money to real estate companies? And what are real estate companies doing with that money?
The only possible explanation is that banks are essentially giving fresh loans to real estate companies so that the companies can repay their old loans. This has allowed real estate companies to not cut prices on their unsold inventory. If bank loans had not been so forthcoming, the real estate companies would have to sell off their existing inventory to repay their bank loans. And in order to do that they would have to cut prices.
But that hasn’t happened. Interestingly, between November 2008 and November 2013, total loans given by banks (excluding food credit) grew by 57.4%. During the same period lending to commercial real estate grew by 86.2%.
And this is what has kept real estate prices high. As Pankaj Kapoor, owner and managing director, Liases Foras, a real estate rating and research firm, 
told Business Today recently “if capital availability becomes difficult, developers may have to cut prices to push sales.”
It is also worth remembering that the average life of a private equity fund is seven to eight years. And all that money that private equity investors have brought in over the last few years, will now have to be returned by real estate companies. In order to do that real estate companies will have to sell the existing inventory that they have piled up.
As Bhandari points out “With the average life of private equity fund being around 7-8 years, the Year 2013 marks the beginning of private equity returning back to shores. The imperative is to see down inventory and return the capital back to investors…The exit of private equity, a fair weather friend of developer, is going to create distress sale situation in real estate industry, shortly. This would lead to depressing price situation for the next 18 months, scaring further fund raising in this sector.”
Another factor that could work towards real estate prices falling are the impending Lok Sabha elections. A lot of black money of politicians is locked up in real estate. And this will have to be unlocked in order to get money to fight elections. As Bhandari points out “According to various estimates an election for central government can cost upwards of US$ 5-6 bn, while average state government elections costing around one billion dollar. With impending central and state election in ten states, costing around US $15 bn, Real Estate will witness outflow of money to fund these elections over the next 18 months.” A similar trend played out before the 2009 Lok Sabha elections when prices fell by around 20% in many markets. But that was also an impact of the start of the current financial crisis with the investment bank Lehman Brothers going bust.
Whether this happens again remains to be seen, simply because as Keynes said ““
markets can remain irrational longer than you can remain solvent.”
 The article originally appeared on www.firstpost.com on January 7, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)