Month: July 2015 | Page 4

21 July, 2015

On the edge: Is Indian real estate heading for a 50% crash in prices?

We all know that real estate in India is terribly expensive and is now selling at prices making it practically unaffordable for almost everybody who wants to buy a home to live in. But how expensive is expensive? This is an important question that needs to be answered.

One way of looking at this problem is through the rental yield available on houses at any point of time. Rental yield is the annual return that can be earned by renting out a house. The number is obtained by dividing the annual rent of the house by its market price.

And what is the rental yield in India? As Ashwinder Raj Singh is CEO – Residential Services of JLL India points out in a June 2015 column in The Indian Express: “Rental yields vary across the globe, but an average of 2 per cent of rental yield is considered a good deal for residential properties in India.”

Singh goes on to write: “In India, the cities which currently offer a higher rental yield are Mumbai, Pune, NCR-Delhi, Bengaluru, Kolkata, Chennai, Hyderabad, Ahmedabad. All these cities offer a rental yield of 2 per cent and above, and you can be assured that the average is not going down anytime soon. Investing in these cities will offer you the maximum returns on investment in properties bought for generating rental income.”

Why would anyone invest for a return of 2 percent is a question that only perhaps Singh can answer? And at 2 percent the rental yield is already very low. We will leave this argument for another day.

Hence, we have an expert telling us that an average rental yield of 2 percent is considered good in India at this point of time. But is it enough? In a recent research report titled Real Estate: The Unwind and its Side Effects analysts Saurabh Mukherjea and Sumit Shekhar of Ambit provide the answer.

As they write: “In a fairly-priced real estate market, the rental yield tends to be somewhere close to the cost of borrowing. Instead, Mumbai has a rental yield of close to 2% (this is gross of tax and maintenance charges) whilst the lending rate hovers around 10%. The difference between lending rates and rental yields is one of the highest.”

What Mukherjea and Shekhar are essentially saying is that the rental yields in India are totally out of whack.

As the chart (Exhibit 11) shows us, even China which has had a huge real estate bubble going has a rental yield better than that of India. In fact as the next chart (Exhibit 12) shows the difference between the interest rate at which money can be borrowed and the rental yield is one of the highest in the world, in India. At this point of time a home loan can be borrowed at 10 percent whereas the rental yield is 2 percent, a difference of 8 percent.

What does this tell us? The rental yield as explained above has two inputs: the annual rent and the market price of the house. A rental yield of 2 percent means that the market price of homes in India has risen at a much faster rate than the rents.

And why is this the case? As Mukhejea and Shekhar write: “Rental yields in property markets in India have remained extremely low as compared to its other Asian peers thereby pointing to the over-valuation of this asset class mainly because it can absorb black money.”

The rental yield cannot continue to remain out of whack. For it to come to the right level, the rents need to rise or the market prices of homes need to fall. Given the surfeit of homes available right now, it is highly unlikely that rents will rise. The chances of property prices falling are significantly higher.

As the Firstpost editor R Jagannathan wrote in a column in November 2014: “In India, borrowing costs for home loans are around 10.5-11 percent currently – when rental yields are a fourth of that level. If rental yields in India have to catch up with those in New York and London, Indian property rates have to fall by a third to a half.”

Mukherjea and Shekhar of Ambit make the same point when the say: “Even if one assumes that buyers are willing to live with only 5% rental yields (as they might have an extremely bullish view of capital gains arising from real estate in India), this would imply halving of real estate prices in Mumbai.” What is true about Mumbai is also true about other parts of the country.

Let me explain the maths through an example. Let’s say an individual buys a home for Rs 50 lakh. The rent that he can earn on this is Rs 1 lakh, meaning a rental yield of 2 percent (Rs 1 lakh expressed as a percentage of Rs 50 lakh).

For the rental yield to rise to 5 percent, what has to happen? One option is that the rent needs to rise to Rs 2.5 lakh. This would mean a rental yield of 5 percent (Rs 2.5 lakh expressed as a percentage of Rs 50 lakh). But as I explained above, the chances of rents going up at this dramatic rate are simply not there.

Hence, what needs to happen for the rental yield to be around 5 percent? Market price of homes needs to fall. A rent of Rs 1 lakh would lead to a rental yield of 5 percent, if the market price of the home is Rs 20 lakh (Rs 1 lakh expressed as a percentage of Rs 20 lakh). This means that the price of the home needs to fall from Rs 50 lakh to Rs 20 lakh or a fall of 60 percent. At a 50 percent fall, for a rental yield of 5 percent, the rent needs to rise to Rs 1.25 lakh (Rs 1.25 lakh expressed as a percentage of Rs 25 lakh).

This is the point that Mukherjea and Shekhar are trying to make.

While the maths looks all fine, the question is will this happen and how soon will this happen? The only way this will happen is if the black money going into real estate slows down to a trickle so that only genuine buyers are left in the market. This is easier said than done. The Modi government has had some focus on black money and let’s hope that continues and improves in the days to come, with the government focussing on domestic black money as well. A point worth repeating here is that ultimately almost all the black money is domestic given that it is generated within the country.

Also, it is worth remembering here that real estate prices don’t fall as rapidly as stock markets do. So, the right answer here is that real estate prices will fall and they will fall dramatically, but only over a period of time.

Stay tuned. The massacre has just started.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on July 21, 2015

21 July, 2015

Lessons in competition from a taxi driver in Goa

If I were to ask you, what is common between Bangalore and Goa, what would you say? Actually, I could even ask you what is common between Delhi and Goa? Or for that matter Chennai and Goa? And to some extent Mumbai and Goa?

If you are the kind who goes to Goa regularly, you would know that the taxi drivers in Goa are a pain to deal with. They remind you of the auto-rickshaw drivers of Bangalore, and Delhi, and Chennai, and to some extent Mumbai, who are an equal pain to deal with and always want to be paid more. These guys would rather sit and idle away their time than take people from one place to another, which is what they are supposed to do.

Sometimes I wonder why are these guys in the business of transportation in the first place, given that they don’t want to go anywhere?

But jokes apart, why is this the case? Why do the autorickshaw drivers more or less all over the country, and the taxi drivers of Goa, behave in the way they do? The reason they behave in a similar way is because they know that they have no competition. If some competition were to come along, their obnoxious behaviour is likely to improve. While nothing works better than some completion, things are not as straightforward as that.

On a recent visit to Goa, I found the taxi driver (who also owned the cab) driving me around to be slightly worried about his future as an owner of two taxis. As the conversation went along I found that he was worried about taxi operators like Ola, Uber etc., entering the state.

They would offer a significantly lower price than what the taxi operators currently charge and in the process end up driving them out of business. “We are thinking of doing a chakka jaam against this,” the driver told me. “Otherwise thousands of taxi owners will be out of work.”

There is a lot that this statement tells us about how incumbents in a particular line of business behave when they are about to face new competition which is likely to make things more difficult for them. Along the lines of the taxi-driver who drove me around Goa, the drivers of kaali-peeli taxis and the autorickhaws of Mumbai are also a worried lot. Recently there was a strike to protest against the new kids on the block (read Uber/Ola etc.).

Further, conversations I have had with many kaali-peeli taxi drivers in Mumbai tell me that their daily earnings are down. A couple of them told me that their earnings are down by around 25%.

As Raghuram Rajan, the current governor of the Reserve Bank of India wrote in Saving Capitalism from the Capitalists (co-authored with Luigi Zingales): “Throughout its history, the free market system has been held back, not so much by its own economic deficiencies as Marxists would have it, but because of its reliance on political goodwill for its infrastructure. The threat primarily comes from…incumbents, those who already have an established position in the marketplace. The identity of the most dangerous incumbents depends on the country and the time period, but the part has been played at various times by the landed aristocracy, the owners and managers of large corporations, their financiers, and organised labour.”

In the case of Goa these incumbents are the existing taxi owners and drivers, who are organised. They have had an easy ride up until now. So is the case with autorickshaw drivers in cities all across in India. With almost no competition, they have been fleecing consumers for years now.

The trouble is that in all this no one thinks about the end consumer. In case of Goa, the end consumers are the huge number of tourists who visit the state every year. Data from the Goa Tourism department shows that in 2014 a total number of 4.05 million tourists came to Goa. Of this around 5.13 lakh tourists came from abroad. The remaining 3.54 million tourists were Indians.

Hence, if some competition were to be introduced in the taxi-cab space in Goa, it would benefit tourists who come to the state tremendously. They would be able to get cabs to go around at reasonable rates and wouldn’t feel fleeced every time they decide to use a cab. Their holiday would be a much more pleasurable experience than it currently is. This is true about other Indian cities where people are dependent on auto-rickshaws for transport.

The trouble here is that unlike the few thousand odd taxi owners, the 4.05 million tourists do not have an organised voice. And given that there is no way they can put across their point of view. Further, most of them visit the state just as tourists and do not live there. Hence, even if they had a voice, there would be no commitment to the cause.

This brings me to Bangalore, Delhi and Chennai (actually Delhi has improved a bit in the last few years). The cities needs to stop being held to ransom by autorickshaw drivers. The citizens deserve better.

Given this, it is time to move to the likes of Ola and Uber, lock, stock and barrel. At least, till their prices are competitive enough. These companies if they have to survive will eventually end up raising rates, and we will end up having another headache on our hands. Nevertheless, until then the autorickshaw drivers and owners need to be put in their place.

Also, the government needs to think about the consumers, who do not have voice, as well. As Rajan and Zingales put it: “The most effective way to reduce the power of incumbents to affect legislation is to keep domestic markets open to international competition…Openness creates competitions from outsiders-outsiders that incumbents cannot control through political means.”

The column appeared on The Daily Reckoning on July 21, 2015

21 July, 2015

Greece is now a political crisis not just an economic one

Last week Greece was bailed out for the third time. The total bailout amounts to 82-86 billion euros. In order to access this money the Greek government has to follow a series of austerity measures like pension reforms, implementing the highest rate of value added tax for business sectors which currently pay a lower rate, etc.
Before the bailout was announced many economists were of the view that Greece should leave the Eurozone. Eurozone is essentially a term used to refer to countries which use the euro as their currency.
The logic offered by these economists is fairly straightforward: Greece needs to get out of the euro and start using its own currency, the drachma. In this situation, the drachma would fall in value against other currencies and in the process make the Greek exports competitive. This would help revive Greek exports as well as tourism, and in turn the Greek economy.
The austerity measures that Greece has had to follow since 2010, when it was first bailed out, have crippled the Greek economy. The economy has contracted by 25%. The unemployment is at 26%. Among youth it is over 50%. Small and medium businesses are shutting down by the dozen.
The government debt as a proportion of the gross domestic product (GDP) has jumped from 126.9% in 2009 to 175% currently. This has happened primarily because the size of the Greek economy has contracted leading to the total amount of debt as a proportion of the GDP(which is a measure of the size of an economy) shooting up.
If Greece leaves the euro and moves to the drachma, it will be in a position to devalue the drachma and in the process hope to revive its economy. This is something that it cannot do currently given that it uses the euro as its currency.
The economists who have been calling for Greece to leave the euro are looking at the situation just from an economic point of view. What they forget is that euro has political origins.
The euro came into being on January 1, 1999. But it took a long time for the countries which originally started to use the euro as their currency to get there. A brief history is in order.
Before the euro came the European Union. The origins of the European Union can be traced to the European Coal and Steel Community (ECSC) and the European Economic Community (EEC) formed by six countries (which were France, West Germany, Italy and the three Benelux countries i.e. Belgium, Netherlands and Luxemburg) in 1958.
The goal of ECSC was to create a common market for coal and steel in Europe. The EEC on the other hand worked towards advancing economic integration in Europe. The economic integration of Europe was deemed to be necessary by many experts to create some sort of bond between different countries in a continent destroyed by extreme forms of nationalism during the Second World War.
As the Nobel Prize winning American economist Milton Friedman wrote in a 1997 column: “The aim has been to link Germany and France so closely as to make a future European war impossible, and to set the stage for a federal United States of Europe.”
The EEC and the ECSC organisations gradually evolved into the European Union (EU) which was established by the Maastricht Treaty signed on December 9 and 10, 1991. After the formation of the EU by the passage of the Maastricht Treaty, the members became bound to start a monetary union by January 1, 1999.
What this tells us loud and clear is that the euro was as much a political project as it was an economic one. Given this, asking Greece to leave the euro, is not an easy decision to make politically, as it goes against the basic idea of the United States of Europe. As long as the European politicians are serious about this basic idea, Greece will continue to stay in the Eurozone.
The issue has taken another political dimension with the United States (US) of America getting involved. The US isn’t directly involved but as is often the case, it is operating through the International Monetary Fund (IMF).
On July 14, 2015, the IMF released a four- page report in which it said that the Greek public debt is unsustainable. Public debt is essentially government debt minus government debt that is held by the various institutions of the government.
As the IMF report pointed out: “Greece’s public debt has become highly unsustainable…Greece’s debt can now only be made sustainable through debt relief measures that go far beyond what Europe has been willing to consider so far.”
The IMF wants Europe to handle the Greece issue with more care. “There are several options. If Europe prefers to again provide debt relief through maturity extension, there would have to be a very dramatic extension with grace periods of, say, 30 years on the entire stock of European debt, including new assistance… Other options include explicit annual transfers to the Greek budget or deep upfront haircuts,” the IMF report points out.
Basically there are three things that the IMF wants. First, it feels Greece should be allowed more time to repay the debt that it owes to the economic troika of IMF, European Central Bank and European Commission. The IMF wants to give Greece a 30 year moratorium on its debt.
Third, it wants Europe to help Greece more by giving more money to the country ever year. And fourth, it wants lenders of Greece to take a haircut, which basically means that they should let Greece default on a part of the debt that it has taken on.
The question is why are the Americans doing this? A simple explanation for this is that if Greece is abandoned by Europe it could approach China or Russia for help. And this is something that the Americans won’t be comfortable with. A television analyst used to making flippant statements could even call it the start of the second Cold War.
The trouble is that IMF released this report after the third bailout of Greece had been announced. As Albert Edwards of Societe Generale put it: “I simply do not understand why the IMF did not come out loud and clear…and say they would not participate in this charade without debt forgiveness.”
The mess in Eurozone just got messier.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column appeared in the Daily News and Analysis on July 21, 2015

20 July, 2015

How UPA govt subsidies helped generate black money and contributed to the real estate bubble

One of the points that I have made over and over again in the columns that I have written on black money is that theNarendra Modi government needs to concentrate on domestic black money as well.

Since coming to power in May last year, the Modi government has made a lot of noise and come up with legislation on trying to curb the black money leaving the shores of this country. Black money is essentially money which has been earned but on which tax has not been paid.

Nevertheless, it is important to realise that ultimately almost all the black money is domestic i.e. it is generated within the country when people earn money (through legal or illegal means) and do not pay any tax on it.

Given this, it is more important to concentrate on trying to bring down the total amount of black money being generated instead of trying to get back the black money that has already left India. One way to do this is to get more people under the income tax net. Efforts are being made on this front.

A PTI report points out that: “The income tax department has launched an ambitious drive to bring under its net 10 million new taxpayers, after the government recently asked the official to achieve the target within the current financial year.”

Region wise targets have been set. Pune leads the list with a target of more than 10 lakh new assesses. This is an interesting move and if it is successful this will lead to more people paying income tax and hence, the total amount of black money within the system will come down.

When the total amount of black money comes down, lesser black money will go into real estate. And this will help in ensuring that only those who really want homes to live in,will buy. This will help in controlling real estate prices.

Other than getting more people to pay income tax, the government also needs to concentrate on blocking leakages on the subsidy front. In 2004-2005, the total subsidies offered by the government stood at Rs 47,432 crore. By 2013-2014, this number had ballooned to Rs 2,54,632 crore. The total subsidies of the government had jumped by 5.4 times during the period. In comparison, the total expenditure of the government had jumped by only 3.15 times.

Only if the subsidies were reaching those for whom they were intended for, it would not have been a problem. In October 2009, Montek Singh Ahluwalia, the then deputy chairman of the Planning Commission had said: “a Plan panel study on PDS [public distribution system] found that only 16 paise out of a rupee was reaching the targeted poor.”

So where did the remaining 84 paise go? It was stolen in between. Obviously people who stole the subsidies would neither be declaring this money as income and nor be paying any income tax on it.

As Saurabh Mukherjea and Sumit Shekhar of Ambit write in a recent research titled Real Estate: The unwind and its side effects: “Subsidies under the UPA regime grew at a staggeringCAGR[compounded annual growth rate] of 19% per annum…A substantial portion of these subsidies(30-50%) was pilfered by the political class and used by them to fund investment in gold and real estate.”

In comparison to Ahluwalia’s estimate, Mukherjee and Shekhar are being extremely conservative. Nevertheless, the point being made is the same—that government subsidies are terribly leaky. The politicians who stole this money obviously did not declare this as income. This black money then found its way into real estate and drove up real estate prices.

As a FICCI report on black money published in February 2015 points out: “The Real Estate sector in India constitutes for about 11 % of the GDP of Indian Economy, as these transactions involve high transaction value. In the year 2012-13, Real Estate sector has been considered as the highest parking space for black money.”

So what has happened since the UPA was voted out of power? In 2015-2016, the total amount of subsidies have been budgeted at Rs2,43,811 crore, which is lower than the Rs 2,54,632 crore that had been spent in 2013-2014. One reason for this is obviously a fall in oil prices. The number in 2014-2015 had stood at Rs 2,66,692 crore.

This cut in subsidies along with the fact that some subsidies are now directly being paid into bank accounts is likely to help bring down both black money as well as real estate prices. As Mukherjea and Shekhar write: “The NDA has cut subsidies sharply (down 9% in 2015-2016) and is shifting subsidies to Direct Benefit Transfer (DBT); at least 10% of the overall subsidies have already been moved to the DBT. As a result, the ability ofthe politician-and-builder to pilfer subsidies to fund real estate construction has been checked.”

While cutting down on subsidies further may not be politically possible, if more and more of subsidies are paid directly into the bank account of the beneficiaries, the total amount of black money within the system is likely to come down.

Taking these steps rather than chasing black money that has left the shores of this country makes more sense and will have a greater impact on bringing down real estate prices in India. This will go a long way in making homes affordable for those who want to buy homes to live in rather than to invest.

As Mukherjea and Shekhar put it: “the NDA Government is engineering a clamp down on black money in India. The 2015-2016 Union Budget explicitly aimed to disincentivise the black economy and curb the demand for physical assets. With the new Black Money Bill (which was passed by the Parliament on May 26) and with the Cabinet approving the Benami Transactions Bill in May this year, the crackdown on blackmoney will continue further.”

These steps need to continue.

(VivekKaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on July 20, 2015

8 July, 2015

Milton Friedman is having the last laugh on euro

The euro came into being on January 1, 1999. On this day, 11 countries in Europe joined together to form what came to be known as the Eurozone or countries which use the euro as their currency. Greece joined the Eurozone on June 19, 2000, and gave up on its own currency, the drachma.

Fifteen years on Greece is in a terrible economic state. More than 50% of its youth population is unemployed. The economy has contracted by 25% since 2010. And its debt to gross domestic product (GDP) ratio has jumped to 175% from 129% in 2009.

Also, the country has voted against a referendum which essentially asked the citizens whether they were ready to face more austerity measures in return for a third bailout by the economic troika of the International Monetary Fund, the European Commission and the European Central Bank.

The country owes around 240 billion euros to the European Commission, the European Central Bank (ECB) and the IMF. The troika has been lending money to Greece for a while now. As Mark Blyth writes in Austerity—The History of a Dangerous Idea: “In May 2010, Greece received a 110-billion-euro loan in exchange for a 20 percent cut in public-sector-pay, a 10 percent pension cut, and tax increases.”

Every time the troika lends money it demands more austerity measures from Greece. The troika wants to ensure that the budget of the Greek government enters into a positive territory so that the country is finally able to start repaying the debt it owes, instead of borrowing more to repay what it owes.

The troika wants the Greek government to run a surplus i.e. its revenues should be more than its expenditure. As Blyth writes that the idea seems to be to: “Cut spending, raise taxes—but cut spending more than you raise taxes—and all will be well.” The trouble is that the austerity that has accompanied Greece has hurt rather than helped Greece. As the GDP has contracted, the debt to GDP ratio has jumped up majorly.

This vote against the referendum has made Germany more aggressive on the question of allowing Greece to continue staying in the Eurozone. While it is difficult to predict which this will go, my guess is that ultimately Greece will allowed to stay in the Eurozone and the current crisis will be postponed for a latter day, for the simple reason that the euro is ultimately as much a political idea as it is an economic one.

A major reason for which countries within Europe came together to form a monetary union and start using a common currency was to ensure closer economic cooperation and integration in order to ensure that countries in Europe did not fight any more wars against each other. The First and the Second World Wars were the deadliest wars that the world had ever seen.

As the Nobel Prize winning American economist Milton Friedman wrote in a 1997 column: “The aim has been to link Germany and France so closely as to make a future European war impossible, and to set the stage for a federal United States of Europe.”

Having said that monetary unions are not always easy to run. As Friedman wrote: “A common currency is an excellent monetary arrangement under some circumstances, a poor monetary arrangement under others…The United States is an example of a situation that is favorable to a common currency. Though composed of fifty states, its residents overwhelmingly speak the same language, listen to the same television programs, see the same movies, can and do move freely from one part of the country to another; goods and capital move freely from state to state; wages and prices are moderately flexible; and the national government raises in taxes and spends roughly twice as much as state and local governments.”

As far as countries coming together to start using the Eurozone were concerned, their residents spoke different languages, they watched different television programmes and movies and did not really move freely from one country to another. And most importantly different countries needed a different interest rate policy at different points of time.

But within a monetary union with a common currency that is not always possible. And this led to problems within the Eurozone. As Ramesh Ponnuru writes on Bloomberg View: “During the boom years a decade ago, Greece and other countries on Europe’s periphery over-borrowed because interest rates were inappropriately low for them.”

In 1992, before the euro came into being, the German government could borrow at 8% and the Greek government at 24%. By 2007, this difference had largely gone. The German government could borrow at 4.02%. And the Greek government could borrow at 4.29%. When the interest rates for the government fell, fell as dramatically as they did in parts of the Eurozone, the government as well as the private sector ended up borrowing a lot more.

And this primarily led to a huge housing bubble across large parts of the Eurozone. In a normal scenario where there was no monetary union the central bank of a country could have raised interest rates and made it more expensive for the private sector to borrow. This would have ensured that the real estate bubble wouldn’t have gone on for as long as it did.

But the European Central Bank had to keep the entire Eurozone in mind and not just Greece and other weaker countries like Spain, Italy and Portugal. Hence, it allowed the low interest rates to remain low.

In the aftermath of the crisis, the weaker countries in the Eurozone needed low interest rates. As Ponnuru writes: “During the bust, the European Central Bank’s efforts to keep inflation low in the core has led to a punishing deflation in the periphery. The European Central Bank raised interest rates in 2008 and 2011 — at both the start and the middle of Greece’s depressions.”

Even if Greece continues to be within the Eurozone in the days to come, these basic problems with the euro will continue to remain. And that would mean that euro and financial crises will continue to be closely linked.
The column appeared on The Daily Reckoning on July 8, 2015