Month: March 2016 | Page 2

28 March, 2016

Why Do Builders Overbuild

Conversations with friends who live in Delhi and the National Capital Region(NCR) inevitably turn towards the topic of real estate. Over the last two weeks, I met two friends and we ended up talking about the perils of the idea of owning real estate, among other things.

In case of one friend the builder has taken the money and is postponing building the apartments. Meanwhile, the housing finance company has turned a blind eye to this. At the same time, my friend is paying the EMI, though the promised home is nowhere in sight. He continues to pay rent as well. Not a happy situation to be in.

In case of the second friend, the builder ended up building more floors than he had initially promised. My friend was lucky to get possession and move in. But with more floors he is now sharing the infrastructure with more people than was initially planned and this has its own share of problems.

Other than sharing the infrastructure there is a bigger problem which most people don’t even realise. As Sushil Kumar Sayal writes in Inside Unreal Estate—A Journey Through India’s Most Controversial Sector: “When the builder builds a ten-floor block he digs the foundation to a certain depth; when the additional floors are added, does he ensure the foundation is deeper? He doesn’t. The authorities not only turn a blind eye to this safety hazard but are often hand in glove with errant builders.”

The question is why do builders overbuild? The builder-broker nexus essentially leads to overbuilding. As Sayal writes: “There is a close relationship between builders and brokers. Thus, very few builders in and around Delhi put their money into a project upfront. As soon as he wins land in an auction, he collects his band of brokers and sells the project to them. With that money, he pays for the land. The brokers, in return, are assured of space at a discount.”

What this clearly tells us is that the builder has very little of his own money (i.e. equity/capital) riding on the project at any point of time. Also, since he is giving a discount to the broker, he overbuilds. As Sayal writes: “Since he has given a discount to the brokers, the builder overbuilds in order to make money. The extra construction is frequently regularized. Even if it isn’t, nothing stops the builder and brokers from selling it. Often, the builder doesn’t even bother to get a completion certificate.”

The regularisation of the illegal floors happens in the days to come and is easy business for the builder. As Swati Ramanthan wrote in the Mint in June 2014: “State regularization initiatives unfortunately, have become tainted as tools for corruption, or political populism, or as a means to generate revenue for the state. Consider the following: in Kolkata, a meagre ex-parte penalty of Rs.500 per square foot allows regularization of illegal floors.”

In this scenario it is not surprising that the builder builds extra floors and gets away with it. Also, what explains the fact that the builders goes around selling a project which he hasn’t got a total clearance for? The simple answer is greed. But there is a more complicated answer as well. The economic incentive is at work.

As Sayal writes: “Under the law, a builder cannot sell his project unless he has secured all the clearances. These clearances can take up to two years to obtain. Given the high land prices all over the country, no builder can afford to let the investment sit idle for two years. He has no choice but to violate the law and pre-sell the project.”

In fact, this will be the single biggest impediment to the success of the Real Estate (Regulation and Development) Bill, 2013, which was recently passed. I had made this point on December 14, last year. Nevertheless, it is worth repeating here.

The Real Estate Act wants the real estate regulator (to be set up in every state) in order to facilitate the growth and promotion of a healthy, transparent, efficient and competitive real estate sector, to make recommendations to the appropriate state government on creation of a single window system ensuring time bound project approvals and clearances for timely completion of real estate projects.

I guess there is nothing beyond this the central government can really do. So it ultimately boils down to the state governments whether they are in the mood to give a single window clearance for real estate projects.

How good are the chances of something like that happening? The entire process of clearing a real estate project through the various stages is a good money making exercise for both state level politicians as well as bureaucrats.

So the economic incentive is clearly against a single window clearance. Also, much of the money thus raised is used to fight elections at the state level. The builder-political nexus is a huge source of finance to fight elections at the state level for politicians. Will this nexus break down?

You know what I think of it. Nevertheless, let’s wait and watch.

The column originally appeared on Vivek Kaul’s Diary on March 28, 2016

23 March, 2016

The Govt Should Ignore Jewellers’ Strike

The jewellers went on a strike on March 2, 2016. On March 20, it was reported that they had called off their strike after suffering losses of Rs 18,,000 crore. But that did not turn out to be the case. Media reports suggest that on March 21, a section of the jewellers continued to strike.

A PTI reports suggests that: “Most jewellery shops and establishments in the national capital remained shut on Monday despite government’s assurance that there will be no harassment by excise officials. Some jewellers kept their shops shut in Mumbai as well.”

Meanwhile the strike has caused a lot of trouble and heartburn for brides to be. A recent report in The Hindustan Times discusses the plight of women who are about to get married and do not have their gold jewellery in place. The report quotes one such bride to be as saying: “I’m hoping this strike will come to an end soon otherwise I have to go for imitation jewellery on my D-day.”

The brides to be have been left in limbo because the gold jewellers have been on a strike for close to three weeks. The jewellers are striking against an excise duty of 1% on “articles of jewellery [excluding silver jewellery, other than studded with diamonds and some other precious stones]” that the finance minister Arun Jaitley proposed in the budget of the government, for 2016-2017, that he presented last month.

The jewellers are also protesting against the mandatory quoting of the Permanent Account Number(PAN) for cash transactions of Rs 2 lakh or more. This change came into effect from January 1, 2016, and hence, has been place for well over two months. Before this, quoting the PAN was necessary for cash transactions of Rs 5 lakh or more.

Media reports now suggest that the jewellers are claiming that this change has had a huge impact on their sales. Given this, they want the Rs 5 lakh limit to be reinstated.

So what is it that the jewellers fear? They want the government to withdraw the 1% excise duty because they fear harassment by excise inspectors. While this is a legitimate concern, the government has asked excise officials not to make factory visits. A section of the jewellers called off the strike on this assurance from the government. Also, it is important to understand that the 1% duty will generate an extra audit trail.

Further, it is important to understand that gold in its various forms remains an important conduit for black money. Black money is essentially income which has been earned but on which taxes have not been paid.

As the White Paper on Black Money released by the ministry of finance in 2012 points out: “Cash sales in the gold and jewellery trade are quite common and serve two purposes. The purchase allows the buyer the option of converting black money into gold and bullion, while it gives the trader the option of keeping his unaccounted wealth in the form of stock, not disclosed in the books or valued at less than market price.”

The beauty of gold is that a lot of wealth can be stored in a very small space. A lot of black money in the form of gold can be stored in a single locker. Hence, instead of holding on to paper money the holders of black money prefer converting it into gold. Also, with gold there is no fear of wear and tear as is with paper money.

A study on black money carried out by business lobby Federation of Indian Chambers of Commerce and Industry(FICCI) points out that: “Nearly 70-80 % of the transactions involving Jewellery are made using cash (black money).” This clearly explains how those with black money like to hold their wealth in the form of gold.

As the FICCI study points out: “Undisclosed sale of gold, silver etc. results in escapement of applicable tax liabilities Tax authorities have estimated purchases of gold bullion and Jewellery as the second-largest parking space for black money, next to Real Estate.”

Given this, the move to make PAN card mandatory for cash transactions of Rs 2 lakh or more when it comes to making jewellery purchases, is an important move. If it leads to the sales of jewellers falling, then so be it. The black money wallahs might figure out alternative parking spaces for their money, but then why should the government make it easy for them? I mean you should not be able to get out of your house, walk down your street and convert your black money into gold. It has to be a little more difficult than that.

The FICCI study further points out that: “Apart from unreported cash transactions that lead to black money, jewellers (specifically small jewellers) often sell ornaments that are made using adulterated gold. This practice also contributes to black money, as the jeweller typically does not report the full profit made by selling ornaments at premium rates (when they were made using adulterated gold, which is cheaper).”

Hence, while gold jewellery is a conduit for black money, it also helps generate black money. Further, many jewellers discourage the use of plastic money and customers who want to use their credit card or debit card to make the payment, are typically asked to pay 2% extra.

One excuse offered by jewellers is that many buyers do not have a PAN card. Well, if someone is in a position to pay Rs 2 lakh or more for jewellery, I am sure he can get a PAN card made as well. It shouldn’t be that difficult.

Once these factors are taken into account, it is in the best interest of the country that more jewellers are brought under the tax ambit. And that being the case, the government should not back down on its recent moves and let the jewellers’ strike continue.

The column originally appeared in the Vivek Kaul Diary on Equitymaster on March 23, 2016

23 March, 2016

The Former King of Good Times

Vijay Mallya must be currently one of the most hated and most discussed people in the country. He has defaulted on bank loans of around Rs 9,000 crore and left the country. At least, that is the way most people who know who he is, look at him. He has come to be associated with everything bad that is currently happening to the banks in India.

Nevertheless, he has become a victim of what is called the availability bias. Leonard Mlodinow explains this in his book The Drunkard’s Walk—How Randomness Rules Our Lives through an example.

As he writes: “Which is greater: the number of six-letter English words having n as their fifth letter or the number of six-letter English words ending in ing? Most people choose the group of words ending in ing.”

Why is that? As Mlodinow explains: “Because words ending in ing are easier to think of than generic letter words having n as their fifth letter. But you don’t have to survey the Oxford English Dictionary—or even know how to count—to prove that guess wrong: the group of six-letter words having n as their fifth letter words includes all six-letter word ending in ing.”

This type of mental mistake is referred to as the availability bias. As Mldowinow writes: “In reconstructing the past, we give unwarranted importance to memories that are most vivid and hence most available for retrieval.”

Mallya has become the victim of this availability bias. Whenever the topic of corporates and businessmen who have taken loans from banks and not paid them comes up, Mallya’s name comes first. Nobody talks about other businessmen who haven’t paid their loans as well.

Why is that the case? Other than being a businessman, Mallya is also a sports enthusiast and a page 3 regular, who gets regularly covered in the media. Over and above his businesses, from airlines to liquor to real estate, Mallya has also owned an IPL cricket team and a Formula One racing team. Hence, he gets regularly covered in the media and has top of the mind recall among people.

And given that he has a top of the mind recall, the media has covered his loan shenanigans more extensively than other businessmen. Hence, he has become associated with the corporates defaulting on banks loans, more than anyone else.

As Daniel Kahneman writes in Thinking, Fast and Slow: “People tend to assess the relative importance of issues by the ease with which they are retrieved from memory—and this is largely determined by the extent of coverage in the media. Frequently mentioned topics populate the mind even as others slip away from awareness. In turn, what the media chooses to report corresponds to their view of what is currently in public’s mind.”

It’s a little bit of a chicken and egg story here. Because Mallya has top of the mind recall, the media writes about him. And because the media writes about him he has top of the mind recall among people.

Vijay Mallya owes banks around Rs 9,000 crore. As on December 15, 2015, the total gross non-performing assets (or bad loans) of banks of the loans they have given to corporates, stood at around Rs 2.59 lakh crore. Mallya’s contribution to the total corporate bad loans is only around 3.5%. Hence, there are bigger defaulters out there, who the banking system and the government need to deal with, and the media need to write about. But that doesn’t seem to be happening.

This is not to suggest that Mallya is god’s gift to mankind and is being needlessly victimised. At the same time, he is nowhere the villain he is being made out to be. As Mlodinow writes: “By distorting our view of the past, the availability bias complicates any attempt to make sense of it.”

Mallya’s king of good times image, in the minds of people, is now working against him. This is not helping the former King of good times in his bad times.

The column originally appeared in Bangalore Mirror on March 23, 2016

22 March, 2016

Vijay Mallya Is Just A Small Part Of The Big Banking Problem

If media coverage were to be a reflection of the scale of any problem, then it can safely be said that Vijay Mallya has all alone been responsible for the crisis in the Indian banking sector.

But that is clearly not the case.

Mallya owes Indian banks around Rs 9,000 crore. This is a very small amount when we look at the total amount of money owed by various corporates to Indian banks. The minister of state for finance Jayant Sinha shared some interesting data in a written reply to a question in the Lok Sabha, on March 11, 2016.

The accompanying table shows us how big the problem of banks’ lending to corporates actually is.

Rs. in Crore
Corporate Lending
Year	Gross Advances	Gross NPAs	GNPA Ratio
2012-13	31,11,761	1,00,118	3.22
2013-14	34,06,025	1,54,955	4.55
2014-15	36,15,133	1,93,123	5.34
2015-16 (till Dec. 15)	38,41,836	2,60,653	6.78

The gross non-performing ratio has more than doubled between 2012-2013 and December 15, 2015. It has jumped from 3.22% to 6.78%. The gross non-performing ratio is essentially obtained by dividing gross non-performing assets by gross advances or total loans given by the banks, in this case to corporates.

And how do we define gross non-performing assets? As the per the Reserve Bank of India: “An asset…becomes non performing when it ceases to generate income for the bank.” When the corporate borrower stops paying interest and repaying the principal on a loan(a loan is an asset for a bank), the bank typically allows for a grace period of 90 days. After this grace period is over, the bank categorises the loans as a non-performing asset and starts setting aside money (or making provisions) for it. The total sum of such loans forms the gross-non-performing assets.

It is worth remembering here that a loan being categorised as a gross non-performing asset does not mean that all is lost for the bank when it comes to that particular loan. The bank can recover money from the asset that has been offered as a collateral against the loan. Of course this is not as straightforward as it sounds.

In Mallya’s case, he has also given personal guarantees to banks while taking loans for Kingfisher Airlines. Mallya owes around Rs 9000 crore to banks. This is a very small amount if one compares it to the gross-non-performing assets of corporate lending carried out by banks.

As on December 15, 2015, it was at Rs 2,60,653 crore. Mallya’s Rs 9,000 crore works out to around 3.5% of the total corporate gross non-performing assets. The percentage would be even more lower if we compare it to the total gross non-performing assets.

Also, Credit Suisse in a report released in October 2015 identifies some of the biggest corporates who are having a tough time repaying the money they have borrowed from banks. The Credit Suisse analysts (Ashish Gupta, Kush Shah and Prashant Kumar): “Going through the annual reports available for ‘House of Debt’ companies, we find instances where auditors have highlighted that the company has been in default for a period of up to 360 days. According to their auditors report, eight of the ten ‘House of Debt’ groups were in default last year. Total debt with these companies in default was at US$53 billion (~48% of total debt with the groups) of which US$37 billion were reported to be in default for 0-90 days by the auditors.”

The corporates which form the House of Debt group are as follows—Adani Group, Essar Group, GVK group, GMR group, Jaypee Group, JSW Group, Lanco Group, Reliance ADAG, Vedanta Group and Videocon Group.

Hence, the point is that the mess in the Indian banking sector is substantially bigger than just Vijay Mallya. It’s just that Mallya with his flashy lifestyle has become the poster boy for these corporates who have borrowed from banks and are now not in a position to repay.

The finance minister Arun Jaitley has been very vociferous about Mallya and has said: “The facts are very clear: Every government agency will take strong action against him. Banks will go all out to recover every single penny.”

Indeed, that is great. Nevertheless, the question is why just Mallya? What about the other corporates who have borrowed from banks and are now not repaying their loans? They owe the banks close to Rs 2,51,000 crore. Mallya owes just Rs 9,000 crore.

Why is the same aggression missing when it comes to the other borrowers?

The nation wants to know.

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

The column originally appeared on Swarajya Mag on March 22, 2016

22 March, 2016

The Rs 90,000 crore Consumer Spending Kicker That the Govt Missed Out On

The Narendra Modi government has increased the excise duty on petrol and diesel nine times since November 2014.

This has ensured that the benefit of falling oil prices has not been totally passed on to end consumers in the form of lower petrol and diesel prices. What has not helped is that the state governments have also increased their share of taxes on petrol and diesel and ensured that the benefits of lower oil prices have not been totally passed on to the citizens of this country.

A press release put out by the Bhartiya Janata Party in February 2016 said that all state governments except Mizoram, Assam, Tamil Nadu, Chhattisgarh and Gujarat, had increased the value added tax on petrol and diesel.

Hence, the increase in excise duty on petrol and diesel, is not the only reason for an increase in the price of petrol and diesel.

Having said that, what would have happened if the benefit of lower oil prices had been totally passed on to the end consumers in the form of lower petrol and diesel prices? Dr Soumya Kanti Ghosh, the chief economic adviser of State Bank of India, has done an in-teresting calculation on this.

As he writes in a recent research note titled If Wishes Were Horses: “Even though international oil prices are at a decade low, yet Government has increased excise duty both in petrol and diesel. So, we made an attempt to calculate total savings of the consumers if Government would not have hiked the excise duty on petrol and diesel products.”

So what does Ghosh’s calculation tell us? As he writes: “By removing only additional central excise duty from petrol and diesel retail selling prices, the hypothetical petrol price per litre would be Rs 47.63 (Actual: Rs 59.63), and diesel would be Rs 38.96 a litre (Actual: Rs 44.96)…If we assume that the consumption of petrol and diesel in FY16 of 95.28 MMT (Apr-Jan: 79.4 MMT), this would have translated into Rs 90,000 crore of savings for the consumers, which could have provided additional demand in the economy to the extent of 1% of GDP….In effect, this means that if wishes were horses, the decline in oil prices in itself may have provided the much needed impetus to demand and we may not have to wait for the pay hikes!” (MMT = million metric tonnes).

This means that if the central government wouldn’t have increased the excise duty on petrol and diesel, consumers would have benefitted to the tune of Rs 90,000 crore. This money would have been spent and pushed up consumer demand to the extent of 1% of GDP. And that would have been a huge thing. As is well known the multiplier effect of consumer spending is significantly better than that of government spending, where leakages are huge.

Of course, if the government did do things along these lines, it would have meant that the fiscal deficit of the government would have gone up. The fiscal deficit is the difference between what a government earns and what it spends. If the government gave up taxes to the tune of Rs 90,000 crore (actually lesser than this, but I will come to it), it’s earnings would have fallen, leading to an increase in its fiscal deficit.

Actually, the increase in fiscal deficit would be lower than Rs 90,000 crore. This is because the increase in consumer demand due to excise duty on petrol and diesel not being raised, would also bring in some money to the government in the form of both direct and indirect taxes.

Further, there were other ways through which the government could look at bringing down its fiscal deficit. For starters, it owns 11.19% stake in the cigarette maker ITC. This stake as on March 21, 2016, was worth a little over Rs 29,600 crore. Why does the government, which runs anti-tobacco advertisements, continue to own a cigarette maker? (I know I keep repeating this point like a broken record).

This stake could have been sold and a significant portion of the increase in fiscal deficit could have been covered. Those who like to support the government on all issues like to point out that ownership of shares of ITC brings in a dividend for the government. Hence, why let go of this regular income?

The question to ask here is what is the dividend yield of ITC? The dividend of ITC is 1.7%. Dividend yield is the total dividend the company has paid out during the year divided by its current market price. The dividend yield of ITC is less than half of the return of 4% available on a savings bank account. Given this, the dividend argument clearly does not work.

Also, the government continues to run many loss making companies. The Economic Survey for 2015-2016 released before the budget points out that public sector enterprises have accumulated losses of Rs 1.04 lakh crore. The government keeps bearing these losses. And the funny thing is that some of these losses are not even a part of the budget.

As economist Jaimini Bhagwati recently wrote in the Business Standard: “Funds will be provided to support continued losses in public sector undertakings including Indian Railways, some of which are not part of the Budget.”

If these loss making companies are shut down and their assets (primarily land) gradually monetised, it will tremendously benefit the government. The government has made some noises along these lines.

As the finance minister Arun Jaitley said in his budget speech: “A new policy for management of Government investment in Public Sector Enterprises, including disinvestment and strategic sale, has been approved. We have to leverage the assets of central public sector enterprises(CPSEs) for generation of resources for investment in new projects. We will encourage CPSEs to divest individual assets like land, manufacturing units, etc. to release their asset value for making investment in new projects.” Let’s hope this doesn’t just end up as a paragraph in a finance minister’s speech.

The disinvestment target at the beginning of the year was set at Rs 69,500 crore. Only Rs 25,312.60 crore was achieved. Hence, if the government had made an effort to earn money through these routes, it wouldn’t have had to increase the excise duty on petrol and diesel, nine times since November 2014.

Also, it needs to be pointed out here is that not all the savings on account of lower petrol and diesel prices, on account of government not raising the excise duty, would have translated into consumer spending.

Some of it is bound to have found its way into bank accounts and other financial savings instruments. Even that is a good thing given that household financial savings have been falling over the years. In 2007-2008, the household financial savings had stood at 11.2% of the gross domestic product (GDP). By 2011-2012, they had fallen to 7.4% of GDP. Since then they have risen marginally. In 2014-2015, the household financial savings stood at 7.7% of GDP.

A higher household financial savings ratio would have worked towards lower interest rates over the long term. Further, the government may not have been able to fund the entire shortfall of Rs 90,000 crore through these ways. Nevertheless, a good portion could have been filled in through the methods highlighted above.

This means that the government would not have had to increase the excise duty nine times. Possibly, four or five times would have been enough. Nevertheless, making money by simply raising excise duty on petrol and diesel was the easy way out, and who doesn’t like to take the easy way out.

The column appeared in Vivek Kaul’s Diary on March 22, 2016