Vivek Kaul
The Reserve Bank of India (RBI) releases the sectoral deployment of credit data towards the end of every month. Data released on September 29, 2014, throws up some really interesting numbers.
Between August 23, 2013 and August 22, 2014, the overall lending by banks grew by 10.2% to Rs 5,729,300 crore.
Between August 24, 2012 and August 23, 2013, the overall bank lending had grown by 16.8% to Rs 5,199,100 crore. Hence, the growth in overall bank lending has slowed down considerably over the last one year.
What are the reasons for the same? A reason offered by banks is that the borrowing has slowed down because of the high interest rates that prevail. But interest rates had been high even around the time same time last year. Nevertheless, the overall lending by banks had still grown by 16.8%. So high interest rates cannot be a reason be the only reason for bank lending slowing down considerably.
A more feasible reason is the increase in non-performing loans of banks. As on March 31, 2013, the gross non-performing loans of public sector banks had stood at 3.61% of total loans. In a recent report ICRA points out that the gross non performing loans of public sector banks is expected to rise to the region of 4.4-4.7% of total loans as on March 31, 2015.
This rise in non-performing loans could be a reason behind banks going slow on giving out loans. They don’t want to see more loans go bad, and hence, have decided to go slow on lending. Nevertheless, the slowdown doesn’t seem to have impacted one particular sector and that is, commercial real estate.
Between August 23, 2013 and August 22, 2014, the lending to the sector grew by 17.6%. to Rs 1,59,900 crore. Between August 24, 2012 and August 23, 2013, the lending to the sector had grown at a similar rate of 17.4% to Rs 1,36,000 crore.
So, the question to ask here is why has the lending to commercial real estate continued to grow at the same rate whereas the growth in overall lending has fallen dramatically? This, under a scenario where real estate companies have a huge inventory of unsold homes all over the country. (To read about this in detail click here and here).
There is no straight forward answer to this question. To make a definitive statement on this, one would need the break up of the amount of lending to commercial real estate by public sector banks and private sector banks. It would be interesting to see the growth in lending to this sector by public sector banks.
As I have mentioned in the past most Indian real estate companies are fronts for the ill-gotten wealth of politicians. And a possible explanation for the lending to commercial real estate continuing to grow at the same rate as it had last year can be that politicians have been forcing public sector banks to continue to lend to real estate companies.
This continued lending has helped real estate companies to continue repaying their old loans to banks. This has allowed real estate companies to not cut prices on their unsold homes. If bank loans had not been so forthcoming, the real estate companies would have to sell off their existing inventory to repay their bank loans. And in order to do that they would have to cut prices.
In fact, there is nothing new about this modus operandi. Ajit Dayal, an investment manager and the founder of Quantum Asset Management Company had made a similar point in a column in October 2009: “Banks have used your money[i.e. depositors’ money] to give it as a loan to real estate developers. Their act of giving the loan to real estate developers gives them badly needed cash. The real estate developers no longer need to sell their real estate to get “cash flow” to stay alive. They got the money from the banks.”
These loans have allowed enough leeway to real estate companies to launch more new projects. As an article in The Financial Express points out “With more than a hundred launches, across the top real estate markets in Mumbai, Delhi, Bangalore and Pune, and attractively-priced offerings, it could turn out to be a cracker of a Diwali for developers.”
As mentioned earlier, the fresh loans from banks has allowed real estate companies to not cut prices. This, despite the fact that they have a huge inventory of unsold homes. In fact, a July 2014 report in The Times of India quotes Pankaj Kapoor of property research firm Liases Foras as saying “In Mumbai, the average cost of a flat is Rs 1.2 crore.”
An estimate made by Forbes put the average income of a Mumbaikar at $5900 or around Rs 3.54 lakh (assuming $1 = Rs 60) per year. This means it would need nearly 34 years of annual income (Rs 1.2 crore divided Rs 3.54 lakh) for an average Mumbaikar to buy a home in this city currently. What this tells us very broadly that homes in Mumbai are very expensive. Similar calculations done for other parts of the country are most likely to show similar results, though probably the situation might be a little better in other cities.
Nevertheless, the real estate companies never get tired of giving us other reasons. One favourite reason often offered is that people are not buying homes because interest rates are very high. This reason was offered yesterday as well, after the RBI decided to keep the repo rate at 8%. Repo rate is the rate at which RBI lends to banks.
The Confederation of Real Estate Developers’ Associations of India, a real estate lobby, said in a statement yesterday that it was “disappointed with the status quo on the RBI policy rates and demands a reduction in interest rates to facilitate lowering of entry barrier and spur demand for the real estate sector.”
Well, even if the RBI were to cut interest rates by 50-100 basis points (one basis point is one hundredth of a percentage) how would it help in home sales, is beyond my understanding.
So what is a reasonable home price to annual income ratio? An April 2013 article in Forbes points out that “The price-to-income ratio looks at the total cost/price of a home relative to median annual incomes. Historically, the typical, median home in the U.S. cost 2.6 times as much as the median annual income (so if the median income in an area was $100,000, the median price of a home would typically be about $260,000: $100,000 * 2.6).”
A similar scenario emerges in Great Britain as well. A January 2014 article on www.economicshelp.org points out that “First time buyers in London are seeing house prices at a record 7.5 times average earnings. For the UK as a whole, the ratio of 4.3 is still above long term trends.” In comparison, if it takes 34 years of annual income to buy a home, what it clearly means is that the real estate companies have clearly priced themselves out of the market.
But this is something they really won’t want to believe because now they are used to the high prices that have commanded over the last few years.
The article appeared originally on www.FirstBiz.com on Oct 1, 2014
(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)