India Needs a Formal Rental Market for “Housing For All By 2022” to Succeed

Trying to rent a house is one of the most nerve wracking experiences one can go through. I have gone through it in three different cities (Mumbai, Pune and Hyderabad). The way the landlords look at you with pity, is a scene straight out of the movies. It’s like their way of telling you, what you haven’t even been able to buy a house? You loser, look at me.

Having found a house and then trying to handle the landlord on a regular basis takes your diplomatic skills to another level (I used to have a landlord once who used to land up every Saturday morning asking for stock tips and then spend a good three hours badgering me for them).

The entire system is built against anyone who wants to live in a rented accommodation or cannot afford to buy a home unless he moves so far away from the city (I am talking about the bigger metropolitan cities here) that the rest of his life is spent commuting to and from office.

The interesting thing is that the rental share of urban housing stock has gone down over the decades. As per the 1961 census it was at 54 per cent and by 2011 it had fallen to 27.5 per cent. This explains why finding a house on rent can be such a pain.

The proportion of homes on rent has fallen dramatically over the years. This, as urbanisation (or the number of people living in cities) has gone up. As per the 2011 census 31.2 per cent of the population lived in urban areas. This figure is expected to go up in the years to come.

Rental share of urban housing stock in India has progressively declined with urbanisationThe fall in rental housing stock is a worrying trend. A major reason for this has been the rent control acts which are in operation in various cities across India. As KPMG points out in a research note titled Decoding housing for all by 2022: “Rent control policies aimed at protecting tenants have had their consequences of deterring investments in rental housing in India, causing the share of rental stock to decline from 54 per cent in 1961 to 27.5 per cent in 2011 which drove EWS/LIG households into slums.” (EWS = economically weaker sections. LIG = lower income groups).

In fact, as the Tenth Five Year Plan Document (2002-2007) points out: “The Rent Control Act, in fact, is the single most important reason for the proliferation of slums in India by creating a serious shortage of affordable housing for the low income families. Low and middle-income families typically live in rented accommodation all over the world and the need for such accommodation in our cities will only increase as the economy modernises, labour mobility increases and urbanisation takes place.” Further, India’s urban rental housing stock is low as per global standard.

The rent control acts lead to a shortage in rental housing in various ways. As the Five Year Plan document points out, it leads to: “Negative effect on investment in housing for rental purposes. • Withdrawal of existing housing stock from the rental market. • Accelerated deterioration of the physical condition of the housing stock.”

Another impact of rent control is to give Indian cities a shabbier look in comparison to cities in other developing countries. With the tenants living under rent control, the landlord has no incentive in renovating the buildings. Just one walk around South and Central Mumbai tells us that very clearly.

In fact, Mumbai has had to bear the brunt of the rent control act. As Sahil Gandhi, Vaidehi Tandel, Shirish Patel, Abhay Pethe, Kabir Agarwal and Sirus J. Libeiro point out in a working paper titled Decline of Rental Housing in India: A Case Study of Mumbai: “There has been near universal consensus that rent controls of the kind seen in Mumbai, known as “first generation rent control”, have a devastating impact on rental markets and, in general, housing and land markets in cities…Rent control in Mumbai has been particularly damaging for the housing market, which is characterized by ownership dwellings constructed mainly for the upper middle class on the one hand and a high incidence of slums housing the majority of the population on the other.”

The point is that if the government’s mission of “Housing For All by 2022” has to become a reality then rental housing needs to pick up in a big way. What is needed first and foremost for this dream to become a reality is a new rental law which is balanced “in favour of both the tenant and the land-lord could be drafted by the central government.” As KPMG points out: “A balanced rental law could help with the development of a formal rental market in India, and to some extent improve occupancy of the unoccupied houses estimated at about two crore.

A new rental law put out by the central government will be the starting point. It will then have to be adopted by the state governments. At least that way some of the locked and unoccupied homes will start hitting the market.

But will that lead to Housing for All by 2022? Only a little. The shortage in housing is at the lower end of the spectrum, as can be seen from the following table.

Housing Shortage in Urban IndiaThe unoccupied homes are more at the upper end.

Hence, for rental housing at the lower end to take off, the rental yield on homes needs to improve. This will only happen once prices come down to more realistic levels. Currently, the rental yield is around 2-3 per cent (the annual rent as a percentage of market price). Nobody in their right minds is going to build homes for rent with a rental yield like that. For rental yields to go up, the cost of constructing homes needs to fall. For this to happen, first and foremost, the cost of land in and around cities needs to fall.

For the cost of land to fall, the government needs to increase supply. This can be done by increasing the FSI allowed on buildings. Further, the government needs to increase supply of land by trying to sell some of the land that it owns in and around cities, land that it inherited from the British colonial administration.

These will be the first few steps towards Housing For All By 2022.

The column originally appeared in Vivek Kaul’s Diary on Equitymaster on August 31, 2016

Why insurance agents don’t talk about death


One of the first things life insurance agents are told while being trained, is to not talk about death, while selling an insurance policy.

And that perhaps explains, why the agents tend to talk about everything from the prospect of good returns to tax savings that can be made by buying an insurance policy.

People don’t like being told that they will die one day. And in case of an untimely death the life insurance policy will come to the rescue of their family, to some extent. Hence, insurance agents tend to talk about everything except untimely death.

Such behaviour stems from the fact that people react to things differently, depending on how they are framed. As Thomas Gilovich and Lee Ross write in The Wisest One in the Room—How You Can Benefit From Social Psychology’s Most Powerful Insights: “Psychologists over the past thirty years have demonstrated time and again that the tiniest change in how a question is worded or how an option is described can radically alter how it is understood—and therefore how people respond.”

So, if life insurance is sold as something you buy for the financial safety of your family in case of your untimely death, it doesn’t get sold. This happens because people don’t like being told about the most obvious truth in life.

Nevertheless, when they are told about returns and tax saving advantages, they queue up to buy the same insurance policy. In fact, another impact of this is that most insurance sold in India is not pure life insurance. Most insurance sold in India is essentially some form of investment with a dash of life insurance being built into it.

This leads to a situation, where people who buy insurance thinking it is insurance, are not adequately covered. In case of untimely death, the insurance payout along with the value of the investment, is unlikely to help the family maintain the same standard of living, as was in the past.

Such behaviour is visible not just when it comes to buying insurance but in other areas of life as well. As Gilovich and Ross write: “[People]…are more impressed by condoms whose manufacturers boast of a 95 per cent success rate rather than a 5 per cent failure rate. They are more supportive of taxes on the rich when the existing level of income inequality is described in terms of how much more the rich earn than the median wage earner than when it is described in terms of how much less the median wage earner earns than the rich.”

Hence, the way an option is framed leads to how people react to it. Let’s go into the issue of inequality a little more through the example of a factory. Let’s say the median salary of a worker working in this factory is Rs 5 lakh per year and that of a manager is Rs 25 lakh.

So the salary of a manager is 400 per cent more than that of a worker. But the salary of a worker is 80 per cent lower than that of a manager. Even though both options mean the same, the 400 per cent option sounds much worse than the 80 per cent option. And that is why Gilovich and Ross say what they do about taxes for the rich.

Another area where framing is put to good use are retail sales. Instead of having sales two or three times a year, retail chains can have lower prices all through the year. It would basically amount to the same thing. But lower prices all through the year, just doesn’t have the same emotional appeal of a discount, which gets people into the buying mode.

The point being that how an issue is framed essentially decides how it ends up in the mind of the consumer and how he or she reacts to it.

This column was originally published in Bangalore Mirror on August 31, 2016

What’s Common Between Egyptian Cotton and Indian Pulses?


In the recent past, Welspun India Ltd, has been in the news for all the wrong reasons.

The US retailer Target terminated its contract with the company for supplying bedsheets. Bloomberg puts the value of this business at $90 million. The stock price of Welspun has fallen by half over the last 10 days (between August 19 and August 29).

Welspun was supposed to supply bedsheets and pillowcases made of Egyptian cotton to Target. It seems that over the last two years, the company had been substituting Egyptian cotton with non-Egyptian cotton.

Fibres made from Egyptian cotton are longer than those made from regular cotton. This makes the fabric stronger. Further, bedsheets made from Egyptian cotton are also softer than those made from regular ones. For these qualities, in Egypt, cotton is also referred to as white gold.

Hence, given that Welspun was using other types of cotton, it wasn’t producing bedsheets that Target wanted it to. In the process, it lost the contract.

As to why Welspun did what it did, I really don’t know and that is not the reason behind writing this piece. What I am basically interested in is Egyptian cotton and the one common characteristic it shares with Indian pulses.

The production of Egyptian cotton has been falling over the years. Estimates made by United States Department of Agriculture – Foreign Agriculture Service (USDA—FAS) suggest that in the 1980s, Egypt grew cotton on an area of 5,00,000 hectares per year. This fell to 4,00,000 hectares per year in the 1990s. By the turn of the century this had fallen to 2,23,000 hectares of area. In 2015-2016, this fell to 1,00,000 hectares of area.

The USDA—FAS suggests that in 2016-2017, the area on which cotton has been planted in Egypt has fallen further to around 50,000 hectares. This is a huge fall of 50 per cent in just one year. The production is expected to fall to 1,50,000 bales from a production of 3,20,000 bales last year.

This is happening primarily because the cotton farmers are concerned “in terms of their ability to market the crop, especially with the lack of strong commitment from the government that it will buy the crop from farmers.” Over and above this, “Egypt’s industry is relying less on the domestic crop which is comprised mostly of extra-long staple and long staple varieties, while users’ needs have shifted to medium and short staple varieties.”

Hence, while there is a demand for long staple Egyptian cotton internationally and there is a premium for it, that doesn’t seem to be the case within the country. This along with the fact that the Egyptian government hasn’t shown a strong commitment of buying cotton, has led to farmers planting less and less of cotton. Instead of growing cotton, the Egyptian farmers seem to be growing rice. The area under cultivation has jumped from 4,62,000 hectares last year to 6,50,000 hectares this year.

In fact, in India, pulses have been going through a similar phenomenon. While, the total production of pulses hasn’t fallen as dramatically as the production of cotton has fallen in Egypt, it hasn’t gone up either.

Take a look at the following chart. This shows the total production of pulses over the last 30 years.

As is obvious, the total production of pulses has more or less been flat over the last thirty years. In 1986-1987, India produced 16.32 million tonnes of pulses. In 2015-2016, the total production was at 17.06 million tonnes, as per the third advanced estimate published by the ministry of agriculture.

What does this tell us? It tells us that production of pulses has more or less been flat over the last three decades, even though the demand for it has gone up. How do we know that? Take a look at the following chart. It shows the total quantity of pulses that India has imported ever year, since 1990-1991.

In 2015-2016, the import of pulses peaked at 5.80 million tonnes. The increased import of pulses shows that the demand for pulses has gone up over the years, as the income has gone up and people have started eating better, leading to a demand for protein based food products. Pulses are an excellent source of proteins for vegetarians.

In fact, it is safe to say that the real demand for pulses is higher than the total production plus import number, given that even after increased imports, the price of different kind of pulses has continued to remain strong. Hence, many people are either not able to afford pulses or have had to simply cut down on its consumption.

A further increase in imports is not the solution given that India is the largest producer, consumer and importer of pulses in the world. The interesting thing is that despite rising prices, over the last few years, the production of pulses hasn’t gone up. This is primarily because the government up until now had been procuring only rice and wheat directly from farmers. It hasn’t been serious about procuring pulses like the Egyptian government hasn’t been serious about procuring cotton.

And given this ready availability of a buyer, the farmers find it safe to grow rice and wheat. This has led to the production of rice and wheat going up at a steady rate. In fact, now we have reached a stage where on the whole we are overproducing rice and wheat and not producing as much pulses and oilseeds as are required.

Along with the farmers preferring to grow rice and wheat what has not helped is the fact that the last two years’ rains have failed. Given that only 16.1 per cent of area under production of pulses is irrigated (2011-2012 data), the total production took a beating.

This year the government has started to buy pulses (like it buys rice and wheat) to build a buffer stock. The idea is to encourage the farmers to grow pulses given that the government is a ready buyer. It remains to be seen whether the procurement machinery of the government can gear up to the challenge of procuring pulses.

As economists Ashok Gulati and Shweta Saini write in The Indian Express: “The existing procurement machinery is more attuned to procuring rice and wheat than pulses — they require an operationally different treatment. This necessitates gearing up the system accordingly.”

Also, on August 26, 2016, the government ordered imports of 90,000 tonnes of pulses in order to add to the buffer stock. Following this procurement, the buffer stock of pulses has jumped to 1.76 lakh tonnes.

The other encouraging piece of information is that area on which kharif pulses (arhar, moong and urad) have been sown this year has gone up dramatically. As on August 26, 2016, the total area on which pulses had been sown stood at 13.94 million hectares, up by around 34.3 per cent from last year.

This basically means that the prices of the kharif pulses will come down in the months to come as the increased production starts to hit the market. At the same time the government needs to step up procurement in order to ensure that a bumper crop doesn’t lead to a dramatic fall in prices. If that turns out to be the case, then enough farmers will not be encouraged to sow pulses again next year and we will end up with the same problem.

This is important given that even the bumper crop won’t be able to cover for the 5.80 million tonnes of pulses that were imported in 2015-2016. Also, the basic problem of Indian agriculture i.e. well-functioning private markets through which farmers can hope to make some money and not be taken for a ride by the intermediaries, continues to remain.

The column originally appeared in Vivek Kaul’s Diary on August 30, 2016


It’s Time the Govt Treated Deposit Holders with Some Respect

Take a look at the following chart. It shows the various kinds of savings that made up for household financial savings in 2013-2014 (the latest data that is available on this front).

Housing Financial savings in 2013-2014

Deposits constituted close to 63.3 per cent of the total household financial savings. Banks deposits formed around 56.7 per cent of the total household financial savings. Hence, bulk of the Indian savings are in the form of deposits in general and bank deposits in particular.

Shares and debentures formed around 1.5 per cent of the total household financial savings. Within that, investment in mutual funds constituted around 0.98 per cent of total household financial savings. Further, investment in shares and debentures of private corporate companies constituted around 0.46 per cent of total household financial savings.

What this tells us very clearly is that the Indian financial media spends a disproportionate amount of time and space, discussing stocks, debentures and mutual funds. A very small segment of India’s population actually invests in them. This also largely explains why the pink newspapers in India, have such small circulation numbers, given that most of the stuff they publish remains irrelevant to a large section of the population.

What the above chart clearly tells us is that deposits are the main form of savings in India. First and foremost, these deposits help both the union as well as the state governments in India. It is mandatory for banks to invest a certain proportion of their deposits in government bonds (i.e. bonds issued both by the union government as well as the state governments).

The statutory liquidity ratio as this ratio is referred to as is currently at 21 per cent. Hence, for every Rs 100 raised as deposits, banks need to invest at least Rs 21 in government bonds. As on August 5, 2016, 29.3 per cent of aggregate deposits of banks were invested in government bonds.

With so much money chasing government bonds, it allows the union government to raise money at a lower rate of interest than would have been the case, if it was not compulsory for banks to invest in government securities.

Over and above the banks, the provident funds as well as the insurance companies also need to compulsorily buy government bonds. This allows the government to raise money at lower interest rates, than would have otherwise been the case.

Further, given that deposits are the main form of savings, it is this money invested by deposit holders with banks, that ultimately finds its way into the lending carried out by banks. It finances almost everything from homes to cars to two-wheelers to credit card spending to infrastructure projects to corporate takeovers.

But for all that they do as a whole, the deposit holders don’t get treated well. In fact, rarely do they even get a rate of interest on their deposits, which is higher than the rate of inflation. Take a look at the following chart.
Average Reat Rate of Return on Deposits
It shows that between 2009 and 2013, the interest rate on fixed deposits was lower than the rate of inflation. This basically meant that the purchasing power of the money invested in deposits, had been going down. Between mid-2014 and now, the rate of interest offered on fixed deposits of one year or more, has been higher than the rate of inflation.

But in the recent past, this gap has started to narrow again. Also, for those in the higher tax brackets, the real rate of return after paying tax on interest that they earn on fixed deposits, must already be in the negative territory. The real rate of return is essentially the difference between the nominal rate of interest on a fixed deposit minus the rate of inflation.

One of the ironies of the Indian tax system is that income that is earned as capital gains is either not taxed at all, or taxed at lower rates, than income which is earned as an interest on a fixed deposit. Further, capital gains made on selling a house or a debt mutual fund are even allowed the benefit of indexation. The question is why are fixed deposit investors not allowed the benefit of indexation as well, while paying taxes?

Indexation basically allows to take inflation into account while calculating the price of acquisition of an asset. This essentially ensures that the capital gains come down. And in the process, so does the tax that needs to be paid on the capital gains.

Such benefits are not available to those who invest in fixed deposits. If all this was not enough, politicians and bureaucrats keep talking about the need for lower interest rates all the time. This is something I discussed in yesterday’s column, where the commerce and industry minister, Nirmala Sitharaman, had talked about the need to lower interest rates by 200 basis-points to help the micro, small and medium enterprises(MSME) sector.

The finance minister Arun Jaitley has in the past on multiple occasions talked about the need for lower interest rates on fixed deposits. In fact, sometime back, Jaitley even said that people should be investing their money in mutual funds, bonds and shares, that finance projects and lead to economic activity. As if fixed deposits do not finance economic activity. For the finance minister of the nation to be saying something as remarkably silly as this, is surprising indeed.

As I explained earlier in the piece, fixed deposits are ultimately loaned out by banks and this creates economic activity in the process. The money invested in fixed deposits is also invested in government bonds which finance the government. Government bonds essentially help finance the fiscal deficit. Fiscal deficit is the difference between what a government earns and what it spends. The money spent by the government also creates economic activity. Hence, saying that fixed deposits do not create economic activity is totally incorrect.

Also, fixed deposits need to offer a real rate of return. One reason for this is that they are used by senior citizens to generate a regular income. In a country, where there is very little social security on offer along with the fact there is almost no specialised care for the elderly and a medical system which basically robs everyone, the least that we can do is to ensure that the interest on fixed deposits is higher than the rate of inflation. Also, as I keep saying deposits are also used to build a corpus for retirement and weddings and education of children.

Given the reasons cited above, it is important that the government treated the deposit investors with some respect and not make them the fall guy, all the time.

The column originally appeared in Vivek Kaul’s Diary on August 26, 2016

Cut Interest Rates by 2 per cent: The New Economics of Nirmala Sitharaman

Nirmala Sitharaman Spokesperson 11, Ashoka Road, New Delhi - 110001.

BA Kiya Hai, MA Kiya,
Lagta Hai Wo Bhi Aiwen Kiya.
– Gulzar in Mere Apne

The commerce and industry minister Nirmala Sitharaman wants the Reserve Bank of India(RBI) to cut the repo rate by 200 basis points.

Yes, you read that right!

200 basis points!

The repo rate is the rate at which banks borrow from the RBI on an overnight basis. One basis point is one hundredth of a percentage. The repo rate currently stands at 6.5 per cent.

I still hold that the cost of credit in India is high. Undoubtedly, particularly MSMEs which create a lot of jobs contribute to exports… are all hard pressed for money and for them, approaching a bank is no solution because of the prevailing rate of interest. I have no hesitation to say, yes 200 bps, I would strongly recommend,” Sitharam told the press yesterday in New Delhi.

What Sitharaman was basically saying is that India’s micro and small and medium enterprises(MSMEs) are not approaching banks for loans because interest rates are too high. Given this, the RBI should cut the repo rate by 200 basis points and in the process usher in lower interest rates for MSMEs.

This, according to Sitharaman, was important because MSMEs create a lot of jobs and contribute to exports, and hence, should be able to borrow at a lower interest rates, than they currently are. As per the National Manufacturing Policy of 2011, the small and medium enterprises contribute 45 per cent of the manufacturing output and 40 per cent of total exports.

Hence, Sitharaman was batting for the MSMEs. But is it as easy as that?

That politicians don’t understand economics, or at least pretend not to understand it, is a given. But Sitharaman is a post graduate in economics from the Jawaharlal Nehru University in Delhi. (You can check it out here). For her, to make such an illogical remark, is rather surprising.

Not that the RBI is going to oblige her, but for a moment let’s assume that it does, and cuts the repo rate by 200 basis points, in the next monetary policy statement, which is scheduled for October 4, 2016, or over the next few statements.

What is going to happen next? Will banks cut their lending rates by 200 basis points? Only, when the banks cut their lending rates by 200 basis points, is the MSME sector going to benefit.

Banks only borrow a small portion of money from the RBI on an overnight basis and pay the repo rate as interest. A major portion of the money that they lend is borrowed in the form of fixed deposits. Hence, lending rates cannot fall by 200 basis points, unless fixed deposit interest rates fall by at least 200 basis points. (I use the word at least because banks tend to cut deposit rates faster than lending rates).

Wil the banks cut deposit rates by 200 basis points? Let’s assume that they do. If the deposit rates are cut by such a huge amount at one go, people will not save money in fixed deposits. Money will move into post office savings schemes, which offer a significantly higher rate of interest in comparison to fixed deposits (which they do even now, but with a cut the difference will be substantial).

Over a longer period of time, money will also move into real estate and gold, as people start looking for a better rate of return, higher than the prevailing inflation. This will lead to the financial savings of the nation as a whole falling. And banks in order to ensure that deposits keep coming in, will have to reverse the 200 basis points cut and start raising interest rates.

This is precisely how things played out between 2009 and 2013, when household financial savings fell from 12 per cent of the GDP to a little over 7 per cent of the GDP. Meanwhile, the interest rates went up, in order to attract financial savings.

This is Economics 101, which a post graduate in economics from a premier university in the country, should be able to understand.

Another important issue that our politicians seem to forget, over and over again, is the importance of fixed deposits, as a mode of saving, in an average Indian’s life. In 2013-2014, the latest year for which data is available, 69.23 per cent of total household financial savings, were in deposits.

Of this nearly 62.02 per cent was with scheduled commercial banks and 4.19 per cent with cooperative banks and societies. Nearly 2.61 per cent was invested in deposits of non-banking companies.

What does this tell us? It tells us that for the average Indian, the fixed deposit is an important form of saving. For the retirees it is an important form of regular income. Now what happens if fixed deposit interest rates are cut by 200 basis points? The regular income from the fresh money that retirees invest, will come down dramatically. Also, when their old fixed deposits mature, they will have to be invested at a significantly lower rate of interest.

This means that they will have to limit their consumption in order to ensure that they meet their needs from the lower monthly income that their fixed deposits are generating.

What about those who use fixed deposits as a form of saving? (I know that fixed deposits are a terribly inefficient way of saving, but that is really not the point here). Those who are using fixed deposits to save money, for their retirement, for the education and wedding of their children, will now have to save more money, in order to ensure that they are able to create the corpus that they are aiming at. This will also mean lower consumption.

Ultimately lower consumption will impact MSMEs as well, because there won’t be enough buyers for what they produce, as people consume less.

Those individuals who are not in a position to save the extra amount in order to make up for lower interest rates, will end up with a lower corpus in the years to come.

The point being that MSMEs do not operate in isolation. And the level of interest rates impacts the entire economy and not just the MSMEs, as Sitharaman would like us to believe.

Further, even if fixed deposit rates fall by 200 basis points, banks may still not be able to offer low interest rates to MSMEs, simply because they need to charge a credit risk premium i.e. factor in the riskiness of the loan that they are maing.

In case of the State Bank of India, the gross non-performing assets of SMEs stands at 7.82 per cent, as on March 31, 2016. This means that for every Rs 100 that the bank has lent to an SME, close to Rs 8 has been defaulted on. This risk of default needs to incorporated in the interest rate that is being charged.

And finally, the interest rates on fixed deposits of greater than one year are currently in the region of 7 to 7.5 per cent. This is when the rate of inflation has already crossed 6 per cent. In July 2016, the rate of inflation as measured by the consumer price index was at 6.07 per cent.

If fixed deposit rates are cut by 200 basis points, the interest rates will fall to around 5 to 5.5 per cent. This when the rate of inflation is greater than 6 per cent. This would mean that the real rate of interest (the difference between the nominal rate and the rate of inflation) would be in a negative territory. This is precisely how things had played out between 2009 and 2013 and look at the mess it ended up creating for the Indian economy.

Given these reasons, it is best to say that Sitharaman’s prescription would be disastrous for the Indian economy.

The column originally appeared in Vivek Kaul’s Diary on August 25, 2016