Month: September 2016

Rents equal EMIs: How Arun Jaitley Can Partially Fulfil His New Pipe Dream

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010In yesterday’s column I had discussed how the finance minister Arun Jaitley’s idea of moving towards a scenario where home rentals will be close to home loan EMIs, is a pipe dream.

On closer consideration, I still think it’s a pipe dream, but there are ways through which a part of it can be achieved if the government is willing to take a few risks by doing the right things. (Before you get around to reading this piece, I would suggest that you read yesterday’s piece here).

Just to recap what Jaitley said earlier this month: “(The) housing market in India, it had picked up. During Mr Vajpayee’s government, bank rates had come down to such an advantageous level that it was easier to buy an apartment than rent it out. That sort of situation had existed where the EMI has been reasonable. I think that’s the direction in which we have to slowly push our economy.”

So how can this be made to happen? As per the 2011 Census India had 2.47 crore vacant homes. Yes, you read that right, 2.47 crore vacant homes. Arjun Kumar makes this point in a research paper titled India’s Residential Rental Housing published in the Economic & Political Weekly dated June 11, 2016.

Out of this 1.36 crore homes were in rural areas and 1.11 crore homes were in urban areas. In rural areas, the vacant homes formed 6.2 per cent of the total homes. In urban areas, the vacant homes formed 10.1 per cent of the total homes. It is safe to say that this number would have crossed 3 crore by now, given that the census estimate is more than half a decade old.

Of course, all of these vacant homes are not up to the mark for the middle class (the primary audience of this piece) to live in, but a substantial part is. (I discuss this in detail in the last issue of The Vivek Kaul Letter. To know how to subscribe, click here).

These homes are not offered on rent for the simple reason that India’s rental laws are essentially screwed up. This basically discourages people from giving homes out on rent. Also, with the rental yield (annual rent divided by market value of the home) at around 2 per cent per year, many people feel that renting a home is simply not worth the risk.

Any overhauling of the rental laws will have to start with the rent control laws prevalent in many cities. This will have to be carried out by state governments. With the Bhartiya Janata Party in power in many states, the central government of which Jaitley is a part can nudge them in that direction. Of course, this will mean antagonising a section of the population that benefits from the rent control laws.

This section, given that it lives in cities, is likely to be very vocal. I mean who wouldn’t like living bang in the middle of a city, and pay Rs 200 per month as a rent. So, there will be a lot of resistance. And given that, is the government ready take this on?

Once it is easy to rent out homes, more people are likely to rent out homes. At the same time, more people are also likely to try and rent homes, instead of buying one. As per the 2011 census, the home ownership rate in India stands at 86.6 per cent. This includes all kinds of homes, from homes with concrete roofs to homes with GI/metal/asbestos sheets as roofs to homes with stone roofs to homes with tiles as a roof to homes with plastic/polythene sheets as roofs to homes with grass/thatch/bamboo/wood/mud roofs to homes which do not have access to drinking water to homes which do not have the latrine facility available within the premises and so on.

Despite this, the ratio of owned homes in India needs to come down. And this can only happen when renting (both from the landlord as well as the tenant’s point of view) becomes easier than it currently is. This will mean lesser demand for new homes, which will lead to stable prices in the long run. This will ensure that the current high gap between rents and EMIs will narrow down. At a rental yield of 2 per cent per year and a home loan interest of 9.5 per cent per year, the EMI turns out to be around 4.5 times the rent (assuming that the home loan amounts to 80 per cent of the value of the home).

The second thing that needs to happen is that India needs electoral financing reform. Currently, the way elections are financed needs a lot of black money. And a lot of this black money that finances elections in India, comes from investments made in real estate.

As Sandip Sukhtankar and Milan Vaishnav write in a research paper titled Corruption in India: Bridging Research Evidence and Policy Options: “For instance, corporations and parties are only legally required to publicly disclose political contributions in excess of Rs. 20,000. This rule allows contributors to package unlimited political contributions just below this threshold value completely free of disclosure. Indeed, in 2014 the Association for Democratic Reforms (ADR) reported that 75 percent of the income of India’s six major parties comes from undocumented sources.”

This can end if political parties are brought under the Right to Information Act and are forced to declare their political contributions. At the same time donations through the various electronic routes or cheques should be made compulsory.

This will have an impact on the total amount of black money that finances the elections in India. And that in turn, will have an impact on black money being invested in real estate as well as real estate prices. This will lead to the gap between EMIs and rents narrowing as well.

The question is, whether Jaitley is ready to bell this cat?

The column originally appeared in Vivek Kaul’s Diary on September 14, 2016

Jaitley’s New Real Estate Pipe Dream: Where Rents Equal EMIs

India-Real-Estate-Market

Nostalgia is a funny thing.  It makes you remember the good things you had and the good things you lost along the way (with due apologies to Bob Marley!).

The finance minister Arun Jaitley recently said: “(The) housing market in India, it had picked up. During Mr Vajpayee’s government, bank rates had come down to such an advantageous level that it was easier to buy an apartment than rent it out. That sort of situation had existed where the EMI has been reasonable. I think that’s the direction in which we have to slowly push our economy.” Jaitley said this at The Economist India Summit 2016, earlier this month, in response to a query on how the government plans to improve the stressed housing market.

What did Jaitley really mean here? First and foremost, he was remembering the good old days of the Vajpayee government (between 1998 and 2004). During those days the rent one had to pay while renting a house, was very close to the EMI one would have had to pay by taking on a home loan and buying it instead.

The question is how did this happen? This is something that Jaitley did not tell us. And one can’t blame him for it, given that there is only so much that one can say in response to a query. The real estate market had seen a boom in the 1990s. By the late 1990s the market had started to crash and kept unravelling over the next few years. Then the dotcom bubble burst in 2000-2001, the stock market fell after the Ketan Parekh scam came to light and the real estate prices crashed.

Hence, for the period that Vajpayee ruled the country, real estate prices were reasonable. In fact, as late as 2005 (a year after Vajpayee lost the 2004 Lok Sabha elections), property prices, even in Mumbai suburbs were fairly reasonable.

So, the EMI was low because the prices were low and it had nothing to do with lower interest rates.
Also, as I have often said in the past, lower interest rates aren’t going to make any difference to Indian real estate. Let’s understand this through an example. Let’s say the property you are looking to buy costs Rs 80 lakh. The bank gives a home loan of 80 per cent against the market price of the home. This amounts to Rs 64 lakh (80 per cent of Rs 80 lakh). The downpayment that will have to be arranged for is Rs 16 lakh. 
The home loan is for a period of 20 years and the interest to be paid on it amounts to 10 per cent per year. (The prevailing home loan rate is around 9.5 per cent. But we will work with 10 per cent just for the ease of calculation).

The EMI on this amounts to Rs 61,761. Let’s say the interest rate on home loans falls (the reasonable EMIs that Jaitley was talking about). Let’s say the interest rate falls by a fourth to 7.5 per cent per year. The EMI will fall to Rs 51,558. This will mean a saving of around Rs 10,203 per month.

Of course, the home becomes more affordable if such a thing were to happen and home loan interest rates were to fall by a fourth.

Now let’s take a look a scenario where home prices fall by a fourth or 25 per cent. The value of the property falls to Rs 60 lakh. The bank now gives a loan of Rs 48 lakh (80 per cent of Rs 60 lakh). This would automatically make more people eligible for the loan than there were when the home loan of Rs 64 lakh had to be taken. The downpayment required falls to Rs 12 lakh. This is Rs 4 lakh lower than the Rs 16 lakh downpayment required earlier, making things significantly easier.

What about the EMI? At 10 per cent per year and for a period of 20 years, it works out to Rs 46,321. This is more than Rs 15,000 per month lower than the earlier EMI of Rs 61,761. Even at 7.5 per cent, the difference in the EMIs comes to close to Rs 13,000 per month. Also, it requires a lower downpayment of Rs 4 lakh. Further, at a lower value of the home, more people would be eligible for the loan, as a lower EMI needs to be paid. A lower EMI can be paid with a lower income.

Also, in this transaction I haven’t assumed a black component, to keep things simple. But if prices fall, the black component also comes down. Also, I  feel a 25 per cent fall, as has been assumed here, will not make much of a difference, the prices need to fall more than that.

The point being if Indian real estate has to get back, prices need to come down. Let’s take the argument forward. Mr Jaitley talks about an era where rents and EMIs were equal. Now, what would it take for the rents to be equal to the EMI, in the time that we live in.

Let’s take the same example again. The value of the home is Rs 80 lakh. The rental yield (rent divided by the market price of the home) these days is around 2-3 per cent. Let’s take the upper end of 3 per cent. At 3 per cent on a home worth Rs 80 lakh, the rent works out to Rs 2,40,000 per year or Rs 20,000 per month.

If one were to buy this house, the bank would give a home loan of Rs 64 lakh (80 per cent of Rs 80 lakh). The EMI on this would work out to Rs 59,656. (Now we assume the real prevailing home loan interest of 9.5 per cent per year).

Over and above this, the buyer would also have to pay Rs 16 lakh as a downpayment. This means that this money will no longer be available for investment. If the buyer had this money in a fixed deposit which paid around 7 per cent per year, this would mean letting go of interest of Rs 1,12,000 per year or around Rs 9,333 per month. Hence, the total opportunity cost of buying a house worth Rs 80 lakh works out to Rs 69,989 per month.

Now compare this to the rent of Rs 20,000 per month. What this tells us very clearly is that renting is a no-brainer as of now, as far as numbers are concerned. Of course, there are other problems associated with renting which an owned home does not have.

If the rent has to be equal to the EMI plus the interest lost on the downpayment, then it has to go up by nearly 3.5 times its current levels. If it has to be equal to the EMI, then the rent has to go up around 3 times. The other option is that the property prices need to crash big time so that EMIs come down dramatically and are equal to the rent. Both options can be ruled out.

What will happen instead is that rents will rise gradually and property prices will fall gradually, in the years to come, but not dramatically (given that there are too many vested interests at work).

Only that is a given.

What this really tells us is that the finance minister Jaitley’s dream of a time where rents are close to EMIs, will remain a pipe dream at best, unless the real estate prices crash big time. Also, there is a fundamental disconnect here, the cost of owning something has to be greater than the cost of renting it.

The column originally appeared in Vivek Kaul’s Diary on September 13, 2016

Buys High and Not Low: That’s the Indian Investor for You

bullfighting

“Buy Low, Sell High,” goes the old stock market wisdom.

But like most stock market wisdom, this is easy to mouth, but difficult to implement in real life. It is very difficult to buy when others are selling and vice versa.

The tendency is to go with the herd because there is safety in numbers. And if things don’t work out as intended, one has someone else to blame as well. “I only did what Mr Singh’s son recommended,” goes the argument.

The question is how do numbers look on this front? Do investors actually buy when market levels are low and sell when market levels are high. Or are they doing exactly the opposite?

Take a look the following chart. That is how the Sensex has looked between April 1, 2011 and March 31, 2016. As can be seen from the chart, the overall trend of the Sensex has been in the upward direction, though it did fall during the course of 2015-2016.

 

Now take a look at the following table.

YearShares and Debentures
(as a % of GNDI)
2011-20120.2
2012-20130.2
2013-20140.4
2014-20150.4
2015-20160.7

Source: Annual Report of the Reserve Bank of India

The table shows the portion of gross national disposable income (basically the GDP number adjusted for a few other things. For a detailed treatment click here) made up for by investments in shares and debentures, which are a part of the household financial savings. In 2011-2012, shares and debentures made up for 0.2 per cent of the gross national disposable income. By 2015-2016, this had jumped up to 0.7 per cent. The household financial savings comprise of currency, deposits, shares and debentures, insurance funds, pension and provident funds and something referred to as claims on government. The claims on government largely reflects of investments made in post office small savings schemes.

What the table clearly tells us very clearly is that a very small portion of Indian retail investors invests in shares and debentures. In fact, these numbers also include the mutual fund numbers.

What do we learn from the chart and the table? As the Sensex went up, so did the investments in shares and debentures.

The trouble is that for some reason, which actually makes no sense, the RBI puts out the data for shares and debentures together. A breakdown of the total amount of money held in the form of shares (or debentures for that matter) is not available. But with the help of some other data we can prove that the Indian investor basically follows the policy of buying once the stock markets have rallied.

As on March 31, 2011, the total amount of money held in equity mutual funds in India had stood at Rs 1,69,754 crore. By March 31, 2016, this number had stood at Rs 3,44,707 crore. The assets under management increase in two ways. The first is because the value of the shares held by the mutual funds goes up. And the second is because of the fresh money being invested into the mutual funds.

As we can see the assets under management have more than doubled in the five-year period. On the other hand, the Sensex returns during the period stood at 30.5 per cent. Hence, it is safe to say that the major part of the increase in assets under management was because of new money coming into the mutual fund schemes.

And this new money kept coming in as the Sensex kept going up. Take the case of what happened between March 31, 2015 and March 31, 2016. The Sensex fell by 9.3 per cent during the course of the year. The assets under management of equity mutual funds on the other hand, went up by 12.8 per cent.

In fact, during the period, the Sensex achieved its highest level on January 29, 2015, when it closed at 29,681.77 points. Between then and March 31, 2016, the Sensex fell by 14.6 per cent. At the same time, the assets under management of equity mutual funds went up by 14 per cent.

This is a clear indication of the fact that investors actually invest in equity mutual funds only after the markets have rallied. Once the market has rallied, the investors probably assume that it will continue to rally.

Hence, I guess, it is safe to say that a similar behaviour is on when it comes to direct investing in stocks as well. And that (along with increase in mutual fund investments) explains why the share of shares and debentures has increased from 0.2 per cent of gross national disposable income in 2011-2012 to 0.7 per cent in 2015-2016.

Of course, one would be able to say this with much greater confidence if the RBI gave an exact breakdown of shares and debentures. I hope that this anomaly is corrected in the days to come.

The column originally appeared in The Five Minute Wrapup on September 7, 2016

Yogeshwar Dutt and the Unhappiness of an Olympic Silver Medallist

yogeshwar-dutt-biography3

The wrestler Yogeshwar Dutt came in for a happy surprise recently. The bronze medal that he had won at the London Olympics in 2012, is all set to be upgraded to a silver medal.

This has happened because the silver medal winner Besik Kudukhov’s dope test recently turned out to be positive. Kudukhov died in a car accident in 2013. Nevertheless, his sample from the 2012 London Olympics had been preserved and was tested again, before the recently concluded Olympics in Rio de Janeiro in Brazil.

Coming on back of Dutt’s disappointing performance in Rio, the silver medal would have indeed made the wrestler very happy. But typically the silver medallists at Olympics tend to be an unhappier bunch.

The Olympic bronze medallists tend to be happier in comparison to the silver medallists. Indeed, this is surprising but true. In a research paper titled When Less Is More: Counterfactual Thinking and Satisfaction Among Olympic Medallists, V.H. Medvec, S.F.Madey and T. Gilovich, provide the example of Abel Kiviat, a 1,500 metres silver medallist in the 1912 Olympics, held in Stockholm. Kiviat represented the United States.

The fact that he came second rattled him till almost the end of his life. As Medvec, Madey and Gilovich point out: “Kiviat had the race won until Britain’s Arnold Jackson “came from nowhere” to beat him by one-tenth of a second. “I wake up sometimes and say, ‘What the heck happened to me?’ It’s like a nightmare.” Kiviat was 91 years old when he said this in an interview with the Los Angeles Times.” Not winning the gold medal turned out to be a lifelong regret for Kiviat. It rattled him in his 90s. Kiviat died at the age of 99.

In fact, the authors studied the 1992 Olympics Games in Barcelona and came to the conclusion that those winning bronze medals seemed happier than the ones winning the silver medal. And this went against conventional logic. As they write: “Olympic competition involving bronze and silver medal winners—in which those who perform better nonetheless feel worse. On the surface this result is surprising because an underlying premise of all serious athletic competition is that athletes should strive as hard as they can, and that the higher they finish the better they feel.”

Nevertheless, that is not how things eventually turn out. And this goes against conventional wisdom. But the thing is that the silver medallists are thinking about the gold that could have won whereas the bronze medallists are looking at everyone below them, who did not win anything.

Their reference points are totally different. As Michael Foley writes in The Age of Absurdity—Why Modern Life Makes It Hard To Be Happy: “Little in human psychology is simple…Consider the differentials. Bronze is aware of only the vast gap between itself and the unmedalled many not even close to the podium – whereas silver sees only gold one hateful step up.”

In fact, the closer the silver medal winner was to winning the gold the unhappier he or she would feel about it.

And that is why the bronze medallists at the Olympics are happier than the silver ones. Though this seems counterintuitive initially, it makes immense sense after one digs a little more into it.

This does not in any way mean that coming second always leads to lesser satisfaction than coming third. As Medvec, Madey and Gilovich write: “Finishing second is truly a mixed blessing. Performing that well provides a number of direct benefits that increase our well being—recognition from others, boosts to self-esteem, and so on. At the same time, it can indirectly lower satisfaction by the unfortunate contrast with what might have been.”

So where does that place Yogeshwar Dutt? In fact, it makes him a silver medallist who should be happy about it, given that he had been a bronze medal winner for close to four years. His reference point is different than that of other silver medallists.

The column originally appeared in the Bangalore Mirror on September 7, 2016

Fiscal Deficit for First Four Months of 2016-2017 is Highest in Eight Years

At the end of every month the Controller General of Accounts (CGA) declares the fiscal deficit of the government, up until the previous month of the financial year. Fiscal deficit is the difference between what a government earns and what it spends.

Hence, as of August 31, 2016, the CGA declared the fiscal deficit number for the period April to July 2016. During the period the fiscal deficit of the central government was at Rs 3,93,487 crore. This was at 73.7 per cent of the annual target for the financial year and is the highest in eight years.

Fiscal deficit a percentage of annual target 

Take a look at the above chart. It shows the fiscal deficit as a percentage of the annual target, for the first four months of the financial year, over a period last twelve years. It is clear that only in July 2007 and July 2008, was the fiscal deficit as a percentage of the annual target, at a higher level in comparison to where it is at during the course of this financial year. The year 2008 was the year when the financial crisis started and the government tried to beat the impending slowdown by spending much more than it what normally did during the first four months of the year.

Another point that needs to be mentioned here is that expenditure of the government is front loaded whereas a major chunk of its revenues start to come in only in the second half of the year. Even with this disclaimer, the fiscal deficit for the first four months of this financial year is worrying, given that one of the biggest expenditure items of the year, the extra salaries and pensions that the government needs to pay to its current and former employees after accepting the recommendations of the Seventh Pay Commission, kicks in only from August 2016.

This higher fiscal deficit is also visible in the gross domestic product number for the first three months of the financial year (April to June 2016). One way of measuring the gross domestic product (GDP) is to calculate the total expenditure by adding the consumption expenditure, the government expenditure, investments and the net exports (exports minus imports).

For the three-month period between April to June 2016, the government expenditure went up by 18.8 per cent (in real terms). This helped the GDP grow by 7.1 per cent. Without this push from the government, the growth would have been much slower at 5.7 per cent, as per Nomura.

The trouble is that the government doesn’t have an unlimited amount of money and if it is spending money without earning it first, it’s bound to push up its fiscal deficit. A higher fiscal deficit comes with its own set of problems, from higher inflation to higher interest rates.

Further, if the government wants to achieve the fiscal deficit target of 3.5 per cent of the GDP, that it set at the time of presenting the budget, it will have to be a little more aggressive about raising its revenues.

Take the case of the disinvestment target for 2016-2017. It has been set at Rs 56,500 crore. The way it has worked in the previous years is that the government has waited all through the year for the stock market sentiment to improve. And then towards the end of the year, the Life Insurance Corporation of India, has been encouraged to buy what the government has had to sell.

In 2015-2016, of the disinvestment target of Rs 69,500 crore, only around Rs 25,312.6 crore was earned. Of this amount, a major chunk came from the Life Insurance Corporation of India. From the looks of it, something similar may happen this year as well. The Life Insurance Corporation picking up shares being sold by the government is hardly genuine disinvestment, with the money moving from one arm of the government to another.

It is worth pointing out here that timing the market by trying to sell when the stock market is peaking, is very difficult to achieve. And the same applies to the government as well. An ideal strategy would be sell the government stake in companies, little by little almost every month. This wait for the market to pick up is not the best way to operate. The moment any disinvestment of shares stops being an event, will be the day, this strategy will really take off.

Further, given its ambitions in the infrastructure sector, the Modi government needs to look at newer ways of raising revenue. One such way is by selling land. As the Economic Survey of 2015-2016 points out: “Most public sector firms occupy relatively large tracts of land in desirable locations. Parts of this land can be converted into land banks.”

These land banks can then be sold in order to raise revenues for the government. This money can go into a sort of an infrastructure fund which can be used to finance the ambitious plans of the government when it comes to roads and railways.

Of course, for this to happen, the reluctance of the bureaucrats to sell land has to be overcome. This reluctance, the Economic Survey comes in large part from the “the fear of ‘causing pecuniary gain’ to the other side.” And this fear will not be so easy to get rid of.

(The column originally appeared in Vivek Kaul’s Diary on September 6, 2016)