Month: August 2015

How state governments are supporting high real estate prices

India-Real-Estate-Market
For any market to work efficiently to arrive at a right price, transactions need to happen. Buyers need to buy and sellers need to sell. Take the case of the real estate market in the country currently. Transactions have slowed down. In many places they have come to an absolute standstill.

Those who own real estate are not selling it. Those who want to buy real estate are in no mood to buy it. A simple reason for this lies in the fact that the real estate prices all over the country are way beyond what most people can afford. Nevertheless, the reasoning is not as simple as that.

The area where real estate is bought or sold has a circle rate decided by the state government. The circle rate is the minimum value at which the actual transfer of a property between a seller and a buyer should take place. Hence, the buyer of the property pays stamp duty to the state government on the circle rate.

Over the years the market price of real estate in India has usually been higher than the prevailing circle rate. This has essentially led to a situation where the transaction is registered at the circle rate or a little higher, and the remaining transaction is carried out in black money.

Nevertheless, in the recent past the situation has reversed. In many parts of the country the prevailing circle rate is now higher than the market price. And this has led to the transactions in the real estate market coming to a complete standstill. People are not buying and selling homes because of this.

TN Ninan made this point recently in the Business Standard where he said that the circle rates at which stamp duty is collected had been raised three or four times by the Delhi government in the last four years. “The scuttlebutt is that the market rates for property have fallen in the ballpark region of 30-40 per cent. Consequently, the circle rates are now about 50-75 per cent higher than the real rates in the market,” he wrote.

A similar point was made S Murlidharan on Firstpost, where he wrote about circle rates in Sriperembudur near Chennai. The going circle rate in the area for residential land is Rs 600 per square foot. But, as he writes, there are no buyers even for Rs 400 per square foot.

This marked disconnect between the circle rates and the market price has brought transactions to a standstill.

As Muralidharan explains: “Suppose a transaction is done at Rs 350, the consequence for the buyer would be he would have to pay stamp duty on Rs 600 even though he bought for Rs 350 and for the seller capital gains on Rs 600 less cost even though he got only Rs 350.”

A buyer does not want to pay stamp duty on Rs 600 per square foot when he is actually paying only Rs 350 per foot to the seller. Along similar lines, the seller does not want to pay capital gains tax on Rs 600 per square foot when he is getting paid only Rs 350 per square foot. Hence, no transaction happens.

A similar situation prevails in parts of Kolkata as well, as this column points out. As mentioned earlier, the situation used to be exactly opposite in the past when the circle rate was lower than the market price. This used to allow a part of the transaction to be carried out in black.

Now that the circle rate is higher than the actual market price, it doesn’t make any sense for those who have black money to invest in real estate in many parts of the country.

The question is why aren’t state governments cutting the circle rates in parts of the country where this situation prevails? One reason lies in the fact that taxing property is seen as an easy way to fill the state government coffers. But with transactions slowing down that won’t remain true anymore. As an official told the Daily News and Analysis, recently in the context of Mumbai: “A majority of registration is lease and leave and licence. Actual buying is quite low. As a result, our revenue is decreasing. We should be generating Rs 6,000 crore to Rs 8,000 crore revenue a year in Mumbai; the current is Rs4,000 crore and below.”

Secondly, the black money of most politicians is invested in real estate. If state governments start bringing down circle rates, this would lead to the unofficial “wealth” of politicians coming down as well. This would happen primarily because transactions will start happening at lower prices. Currently, transactions where circle rates are higher than the market price, transactions have come to a standstill.

What does this mean? If state governments do not allow real estate prices to fall by maintaining high circle rates, then the mess in real estate will continue for a longer period of time. Transactions will not happen and the market will go through a longer “time” correction. And this can’t be good for anyone—buyers won’t be able to buy, sellers won’t be able to sell. The builders will continue holding on to the excessive inventory of unsold homes that they have accumulated over a period of time.
The column originally appeared on Yahoo India on August 18, 2015

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

Is Narendra Modi ready for the creative destruction that Start-Up India will unleash?

narendra_modi
In their brilliant book, Why Nations Fail: The Origins of Power, Prosperity and Poverty, Daron Acemoglu and James A Robinson recount a story from ancient Rome that is relevant even today: “During the reign of the emperor Tiberius, a man invented unbreakable glass and went to the emperor anticipating that he would get a great reward.” Tiberius ruled between 14 AD and 37 AD.

This anticipation of a reward came from the fact that the Roman state did encourage new inventions. Nevertheless, this did not happen and the man was in for a surprise. As Acemoglu and Robinson recount: “He demonstrated his invention, and Tiberius asked him if he had told anyone else about it. When the man replied no, Tiberius had the man dragged away and killed, ‘lest gold be reduced to the value of mud’.”

A similar story comes from the era of Elizabeth I, who ruled England and Ireland from 1558 to 1603. William Lee made a knitting machine in 1589 and approached the Queen for a patent, so that others would not copy his invention and he could cash in on it.

The Queen refused to grant him a patent and told him: “Thou aimest high, Master Lee. Consider thou what the invention could do to my poor subjects. It would assuredly bring them to ruin by depriving them of employment, thus making them beggars.”

Lee went to France and was refused a patent there as well. Back in England, James I (Elizabeth’s successor) also refused to give a patent to Lee’s knitting machine.

By now, dear reader, you must be wondering why I am telling these historical tales, particularly given the headline suggests this is a column on Prime Minister Narendra Modi. Allow me to explain.

In the Independence Day speech Modi gave a few days back, he initiated a new call: “Start-Up India, Stand-Up India”. Whether this was just another marketing slogan Modi and his backroom boys are so good at coming up with, will only become clear in the time to come. But the idea, as Modi explained during the speech, is that each of the 1.25 lakh bank branches all across India “should encourage at least one Dalit or Adivasi entrepreneur, and at least one woman entrepreneur”.

On the face of it, like most of Modi’s big ideas, this makes tremendous sense. Around 13 million Indians enter the workforce every year, and it is start-ups that have the potential to generate the huge number of jobs that India needs to create for its burgeoning workforce.

The trouble is that start-ups also challenge the existing way of doing things and lead to what economists call creative destruction.

Creative destruction was a term coined and defined by Austrian-American economist Joseph Schumpeter in Capitalism, Socialism and Democracy as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one”.

This process of “industrial mutation” challenges the existing paradigm, and it is messy, causing reluctance among governments and politicians to accept the new inventions, discoveries and ideas of start-ups.

Here’s Acemoglu and Robinson again: “For sustained economic growth we need new technologies, new ways of doing things, and more often than not they will come from newcomers such as Lee [in today’s terminology essentially start-ups]. It may make society prosperous, but the process of creative destruction that it initiates threatens the livelihood of those who work with old technologies, such as hand-knitters who would have found themselves unemployed by Lee’s technology.”

The point is that if Modi’s “Start-Up India, Stand-Up India” call is more than a marketing slogan, it has the potential for widespread creative destruction, and this will challenge the incumbents and their way of doing things.

Obviously, the incumbents will try to do everything to stop their businesses from becoming irrelevant…including trying to get politicians on their side.
Take the case of what has happened around the entire issue of “net-neutrality, which the mobile phone companies have opposed tooth and nail because it would make substantial portion of their business model irrelevant.

Or take the case how life is being made difficult for taxi-cab operators like Ola and Uber who’ve challenged the existing paradigm. As Acemoglu and Robinson write: The elite, when their political power is threatened, form a more formidable barrier to innovation. The fact that they have much to lose from creative destruction means not only that they will not be the ones introducing new innovations but also that they will often resist and try to stop such innovations. Thus society needs newcomers to introduce most radical innovations.”

If “Start-Up India, Stand-Up India” goes beyond just being a marketing slogan, a whole host of existing businesses will feel threatened, and will approach the government for relief. Given the close relationship most governments share with existing businesses, they are more than likely to oblige.

Acemglou and Robinson offer the example of manufacturers of woollen textiles in England who, when faced with fierce competition from imported textiles, “lobbied Parliament to pass legislation in 1666 and 1678 that would make it illegal for someone to be buried in anything other than woollen shroud’.

If the creative destruction of “Start-Up India, Stand-Up India” is indeed unleashed, Modi and his government will have to resist the temptations of doing similar things. However, India is ranked 158th among 189 countries worldwide, and last among the eight South Asian countries (Afghanistan, Sri Lanka, Pakistan, Maldives, Bangladesh, Nepal, Bhutan and India) in the World Bank’s annual Ease of Doing Business Rankings.

Before we see creative destruction in India…before Modi is even in a position to grant protections to fading industries…the ease of doing business in India must improve.

I remain sceptical.

(The column originally appeared in The Daily Reckoning on August 19, 2015)

I want to do frandship with you…

facebook-logoThis column should have ideally been written by a woman, given that it concerns what women experience on the social media as well as on the internet. Many women receive random friend requests on Facebook from men stating: “I want to do frandship with you,” or something like “I want to be frands with you”.

Of course it is safe to say that men who send out such requests do not really understand the basic etiquette that one needs to follow on Facebook and other social media. Their English language skills are nothing to write home about. And honestly, I am being a tad euphemistic here.

Nevertheless, there is enough anecdotal evidence to suggest that men who send out such friend requests do not really give up that easily. Even though, their friend requests keep getting rejected, they keep sending out newer ones. Some of them even end up as proper stalkers.

Why is that? Nobel Prize winning economist Alvin E. Roth has a possible explanation in his new book Who Gets What and Why—The Hidden World of Match Making and Market Design. As he writes: “Think of an Internet dating site on which women with appealing photos receive far more messages than they can answer and men find that very few of their messages draw responses. This causes men to send more, and hence more superficial, messages and women to respond to fewer and fewer of them.”

While Facebook is clearly not a dating site, Roth’s logic applies perfectly to the random friend requests that are sent out on Facebook. And this explains to a large extent why some women do not have their pictures as profile pictures on Facebook. It just attracts the wrong kind of attention.

The interesting bit is that the same phenomenon plays out in a different way on matrimonial websites as well. During the course of last week, I met two friends, who, rather late in life have started using matrimonial websites in their quest to get married quickly. The female friend complained that she was getting way too many proposals, and it had become difficult for her to separate the wheat from the chaff.

The male friend on the other hand was disappointed with his search and felt that trying to get married through matrimonial websites was a waste of time. He had been getting proposals at a very slow rate. And this was happening despite him showing interest and sending out many proposals.

So, what is happening here? As Roth writes: “At many interest dating sites…attractive women get more emails than they can answer. The men, who find that many of their emails go unanswered, react by sending more emails.”

Further, unlike approaching a woman in person, it is very easy to send across a proposal over the internet. Hence, many end up sending too many proposals. But as Roth writes in the context of dating websites (and which I feel applies equally to the Indian matrimonial websites): “These emails become less informative, because the men submitting them are less likely to study the information  contained in each woman’s profile and how best to approach her. The women in turn reply to a smaller and smaller percentages of the messages they get, and the men respond by sending even more, and even more superficial, messages.”

This essentially leads to the collapse of the matrimonial market on the internet. Given that messages can be easily sent, more and more messages are sent and ultimately nothing happens. As Roth writes: “Economists call such superficial messages “cheap talk.” When talk is cheap, it doesn’t reliably signal anything.” It leads to congestion setting in, “and that can make it impossible for participants to identify the most promising alternatives the market has to offer.” And that makes the entire situation quite tricky for both men and women looking to get married.

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

The column appeared in the Bangalore Mirror on August 19, 2015

Chinese politicians will do whatever it takes to keep economic growth going

china“The one thing I know for sure about China is, I will never know China. It’s too big, too old, too diverse, too deep. There’s simply not enough time.”
Anthony Bourdain, Parts Unknown

Ideally, I should have written this column last week, but this trend isn’t going anywhere anytime soon.  On August 11, 2015, the People’s Bank of China, the Chinese central bank, engineered a 1.9% cut in the value of the Chinese yuan against the US dollar. This was the largest single day cut in the value of the yuan against the dollar in two decades. The Chinese yuan doesn’t move freely against the dollar. The People’s Bank of China controls its value. Before last week’s cut, 6.2 yuan equalled a dollar.

As I write this on August 17, 2015, around a week later, 6.4 yuan are worth a single dollar. The value of a currency is a big variable for exporters. But by ensuring the yuan had a fixed value against the dollar, the Chinese central bank took this variable out of the Chinese exporters’ equation totally. This helped Chinese exports and exporters flourish and has been a very important part of the Chinese economic miracle.

Nevertheless, Chinese exports have been falling lately. In July 2015, Chinese exports fell by 8.3% compared to a year earlier. Even in June 2015, the exports had gone up by only 2.8%. A major reason for this is that the Bank of Japan, the Japanese central bank, has rapidly driven down the value of the Japanese yen against the dollar. In October 2012, 80 yen made up a dollar. As I write this, around 124.5 yen make up for a dollar. This has made many Japanese exports more competitive than China’s. Further, it has made imports into Japan more expensive. This caused Chinese exports to Japan between January and July 2015 to fall by 10.5%.

So it’s not surprising that the Chinese authorities pushed down the value of the yuan against the dollar. Their goal is to boost Chinese exports while making imports into China more expensive, thereby pushing the sales of local Chinese made goods and boosting economic growth in the process.

The People’s Bank of China decreased its foreign exchange reserves by $300 billion over the last four quarters. In other words, in a bid to keep the yuan at 6.2 for every dollar, the Bank has been selling dollars from its kitty and buying up yuan, which is essentially money being taken out of the country.

The People’s Bank doesn’t have an unlimited supply of dollars. At some point, it had to let the value of the yuan fall against the dollar, which is precisely what it did last week. For years on end, China has grown at double-digit rates. But recently, as global demand has fallen in the aftermath of the financial crisis which started in 2008, economic growth has slowed to 7% per year. In fact, many China followers believe the official 7% figure is an overstatement.

For example, Ruchir Sharma, Head of Emerging Markets and Global Macro at Morgan Stanley, wrote in a recent column in The Wall Street Journal that: “While China reported that its GDP grew exactly in line with its growth target of 7% in the first and second quarters this year, all other independent data, from electricity production to car sales, indicate the economy is growing closer to 5%.”

Most China experts and analysts fail to mention this, but it is important to understand that economic growth gives legitimacy to the unelected communist government that runs China.

As John Plender writes in Capitalism: Money, Morals and Markets:  “Unelected Chinese politicians may put the interests of the Communist Party elite before those of the nations. Their legitimacy, after all, rests chiefly on the continuation of high rates of economic growth. If they fail to deliver, their survival in an economic crisis may depend on whipping up nationalist popular feeling against Japan, Taiwan or other Asian neighbours, intensive trade relations notwithstanding.”

This phenomenon was at play in the recent past, when the Chinese government tried to do everything to stop the stock market from falling. It banned investors with more than a 5% holding in a company from selling shares and it directed big financial institutions to invest in the stock market. These moves were to prop up stocks, but mostly to maintain political legitimacy.

Since the financial crisis, the Chinese politicians have been able to maintain credibility by ensuring that the economic growth has not collapsed, as it has in much of the Western Word. This has been done by lending cheap money across various sectors. As Sharma of Morgan Stanley writes: “The problem is that China’s economic rise of late has been facilitated by a massive and unsustainable stimulus campaign. No emerging nation in recorded history has ever tacked on debt at such a furious pace as China has since 2008, and a rapid increase in debt is the single most reliable predictor of economic slowdowns and financial crisis. China’s debt as a share of its economy increased by 80 percentage points between 2008 and 2013 and currently stands at around 300%, with no sign of abating.”

This easy money first led to a property bubble, which was followed by an infrastructure bubble and a stock market bubble.
The point is that the Chinese politicians will do whatever it takes to keep the economic growth going. So expect the devaluation of the Chinese yuan against the dollar to continue, as China tries to push up its exports again.

As Albert Edwards of Societe Generale writes in a recent research note: “For although the PBoC [People’s Bank of China, the Chinese central bank] said the move was a one-time adjustment [the drop in the value of the yuan against the dollar] to reflect changes in the way it calculates the daily fix, it also said that the price would be set “in conjunction with demand and supply conditions in the foreign exchange market and exchange rate movements of the major currencies.”

What does this mean? Well, the race to the bottom isn’t exactly rocket science. With the yuan’s value now down against the dollar, chances are that the Bank of Japan will respond by printing even more yen, in a bid to further drive down the value of the yen against the dollar. The South Korean central bank may also do something along similar lines in order to drive down the value of the won [the South Korean currency] against the dollar to protect its exports. This in turn will lead to the People’s Bank of China to push the yuan down even further against the dollar. Rest assured, the currency wars in Asia will continue.

The column originally appeared in The Daily Reckoning on Aug 18, 2015

Why Indians still love real estate

India-Real-Estate-Market
Every time I write a column saying that the good days of investing in real estate are over, I get newer theories on why I am wrong. The latest that I have heard is that the government will not allow real estate prices to fall. Oh and there is another one – the seventh pay commission will lead to an increase in salaries of government employees and the higher salaries will be ploughed into owning real estate.

The theories notwithstanding, the question to ask here is, why do Indians love owning real estate? The simple answer is that some of them have got black money to invest. And it’s not so easy to invest black money in other forms of investment like mutual funds, bank fixed deposits, etc. Further, you can see the real estate you own and get a sense of satisfaction from it. It’s a hard asset. The same is not true about other forms of investing.

Having said that if we left it at these reasons, it would be a very simplistic way of looking at the entire scenario. There are multiple other factors at work.
When it comes to real estate, how do minds of people work? Everyone knows someone who has bought a piece of real estate, some land or a home, at a very low price and sold it at a very high price. There are two behavioural biases at work here: anchoring and availability.

When you know of someone who has bought a flat at Rs 10 lakh and sold it at Rs 50 lakh, the Rs 50 lakh number gets anchored in your mind. As John Allen Paulos writes in A Mathematician Plays the Stock Market: “Most of us suffer from a common psychological failing. We credit and easily become attached to any number we hear. This tendency is called the “anchoring effect”.”

Then there is there the availability effect at work as well. Nobel Prize winning psychologist Daniel Kahneman defines the availability effect as the “ease with which instances come to mind”. If you know of someone who has bought a flat at Rs 10 lakh and sold it at Rs 50 lakh, you will recall this example almost immediately.

The anchoring and the availability biases will lead you to believe that there is a lot of money to be made in real estate. But what you are not taking into account is the actual cost of owning real estate. The interest you pay on the home loan. The stamp duty that needs to be paid initially. The property tax that needs to be paid every year. The maintenance charges that need to be paid to the society every month. The risk of owning an under-construction property (where real money is made). The risk of the builder increasing the price. The risk of the builder disappearing (as seems to be happening regularly these days). And so on.

Why are these factors not taken into account? Simply because there is only so much a human brain can process at a time and there is only a limited amount of time to make a decision. This is human weakness is termed as “bounded rationality”. The term was coined by social scientist Herbert Simon. Due to these reasons Indians are firm in their belief that real estate is the best form of investing. And this might have been even true between 2004 and 2013, when the returns from investing in real estate where pretty good.

But since then the returns from investing in real estate have been lower than what you would have made by letting your money sit idle in a savings bank account. The reason is very simple. The prices are way too high. In Bangalore, the weighted average price of a flat is Rs 88 lakh. Given the high prices, the demand has collapsed. And without demand there can be no price rise.

The story has changed and it’s time to wake up and smell the coffee.

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

The column originally appeared in the Bangalore Mirror on Aug 12, 2015