Why stable real estate prices are not good news for builders

India-Real-Estate-MarketThe Financial Express reports today that investments into real estate are at a seven year high. As a news-report in the pink paper points out: “Investments into the real estate sector in 2015, at close to $8 billion or Rs 53,000 crore, are poised for a seven-year high. Much of this has come in via the private equity (PE) route and borrowings through non-convertible debentures (NCD).” This is surprising given the bad state that real estate is in. A possible explanation for this is the availability of “easy money” at low interest rates in large parts of the Western world. This money seems to be finding its way into Indian real estate.

All this money coming into the sector has allowed builders to not cut prices in order to get rid of their unsold homes and use the money thus generated to repay their outstanding banking loans. As the news-report points out: “Had the investments not materialised, developers may have been pushed to drop prices to monetise inventory at a time when demand has been waning. Instead, they’re holding on to inventory.”

This is only partly correct and applies only to those builders who have been getting investments from the private equity route as well as been borrowing through the non-convertible debentures route. And that is not a very large number in a country where there are thousands of builders.

Take the case of the upper end of the real estate market in Mumbai, where private equity money has come in. The unsold inventory of homes continues to be high. Data from real estate research firm PropEquity points out that as on September 30, 2015, 6048 luxury apartments priced above Rs 5 crore continued to remain unsold in Mumbai. Of this 3,662 are in the Rs 5 crore and Rs 10 crore range, and the remaining above that.

Further, real estate prices have corrected in large parts of the country. As Getamber Anand, president of Confederation of Real Estate Developers’ Associations of India (CREDAI), a real estate lobby, said a few days back: “Prices have come down by 15-20 per cent in last one and half years and there is no further scope for reduction.” Hence, the assertion that private equity money and borrowings through the non-convertible debentures route has allowed builders not to cut prices is only partly correct.

Further, those companies that have managed to raise money through private equity and non-convertible debentures are only kicking the can down the road. Also, this money is being raised at a very high cost.

In a recent research note titled The realty reality Crisil points out: “The cost of alternative funding has increased over the last two years as pressure on developers financial position intensified. About one-third of the non-convertible debentures issuances last fiscal yielded an internal rate of return of more than 20%, compared with no issuances of similar yields in 2012.”

You don’t need to be an expert in finance to understand that 20% is a very high rate indeed.

The same stands true for private equity firms as well. As Crisil points out: “As for private equity [firms], the higher return expectation will increase the refinancing risk for the realtors over the longer term, unless the demand picks up substantially. CRISIL estimates payout for private equity funds for the sector as a whole at Rs 85,000 crore, assuming a return of 20% over a 5 year period. Hence, alternative funding sources such as non-convertible debentures and private equity [firms] are expected to continue providing some respite in the short term only.

What does this mean? This means that the real estate companies have essentially managed to postpone their debt problem. Companies have managed to take on new debt and pay off their existing debt to banks. But this new debt also needs to be repaid. And that can only be repaid if companies manage to generate money through sale of homes that they have built. Further, they need to build new homes as well.

This is not going to happen if real estate prices stay stable at their current levels. It will only happen once real estate prices fall from their current levels and buyers start getting interested in purchasing real estate.

Currently, the real estate prices are way too high for buyers to be interested in buying homes. Hence, stable prices are actually not in the best interest of real estate builders. But that is clearly not the way they look at the prevailing situation. As Anand of CREDAI said: “There is no further scope for reduction [in prices].”

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

This article originally appeared on Firstpost on December 14, 2015

Why EMIs and interest rates fall more on front pages of newspapers than real life

newspaperRegular readers of The Daily Reckoning would know that I am not a great believer in the repo rate cuts leading to an increase in home buying and as well as consumption, with people borrowing and spending more, at lower interest rates. Repo rate is the rate at which the Reserve Bank of India (RBI) lends to banks and acts as a sort of a benchmark to the interest rates that banks pay for their deposits and in turn charge on their loans.

A basic reason is that the difference in EMIs after the rate cut is not significant enough to prod people to borrow and buy things. Further, they should be able to afford paying the EMI in the first place, which many of them can’t these days, at least when it comes to home loan EMIs.

These reasons apart there is another problem, which the mainstream media doesn’t talk about enough. All they seem to come up with are fancy tables on how interest rates and EMIs are going to fall and how this is going to revive the economy. And how acche din are almost here. Now only if it was as simple as that.

A cut in the repo rate is not translated into exact cuts in bank lending rates. After any repo rate cut, banks quickly cut their deposit rates. They cut their lending rates as well, but not by the same quantum.

As a recent study carried out by India Ratings and Research points out: “In the recent policy cycle, RBI has cut policy rates since January 2015 by a cumulative 125 basis points, banks have cut one year deposit rates by an average 130 basis points and lending by 50 basis points, which includes the base rate cuts in the last one week. Base rate is the rate below which a bank cannot lend. In the last 18 months three-month commercial paper and certificate of deposit rates have fallen by 150 basis points. Thus transmission of policy rates has been more through market rates and banks deposit rates in the last one year.” One basis point is one hundredth of a percentage.

In an ideal world, a 125 basis points cut in the repo rate by the RBI should have led to a 125 basis points cut in the lending as well as deposit rates. But that doesn’t seem to have happened. While the one-year deposit rates have been cut by 130 basis points, the lending rates have gone down by just 50 basis points.

And this is a trend which is not just limited to the current spate of rate cuts by the RBI. This is how things have played out in the past as well. As Crisil Research had pointed out in a report released in February 2015: “Lending rates show upward flexibility during monetary tightening but downward rigidity during easing. Between 2002 and 2004, while the policy rate declined by 200 basis points, lending rates dropped by just 90-100 basis points. Conversely, in 2011-12, when the policy rate rose by 170 basis points, lending rates surged 150 basis points.

So, the point being that when the RBI starts to raise the repo rate, banks are quick to pass on the rate increase to their borrowers, but the vice-versa is not true.

As India Ratings and Research points out: “The policy cycle is being used by banks to their advantage. A study of the last 10 years shows, that in most cases when policy rates have reduced, deposit rates have comedown faster and the quantum has also been higher compared to lending rates. The same was also true when policy rates were hiked, where lending rates went up and the quantum was also higher compared to deposit rates.”

Also, this time around banks have been quick to cut their base rates, the minimum interest rate a bank charges its customers, after the RBI cut the repo rate by 50 basis points to 6.75%, in September. Having cut their base rates, banks have increased their spreads, and negated the cut in base rate to some extent.
Take the case of the State bank of India. The country’s largest bank cut its base rate by 40 basis points to 9.3%, in response to RBI cutting the repo rate by 40 basis points.

This meant that the interest rate on home loans should have fallen by 40 basis points as well. Nevertheless, the interest rate on an SBI home loan will fall by only 20 basis points. Why is that? Earlier, the bank gave out home loans to men at five basis points above its base rate (or what is known as the spread). To women, the bank gave out home loans at the base rate. Now it has decided to give out home loans to men at 25 basis points above the base rate. In case of women it is 20 basis points.

Hence, interest rate on a SBI home loan taken by a man will be now be 9.55% (9.3% base rate plus 25 basis points). Earlier, the interest rate was 9.75%. This means a fall in interest rate of 20 basis points only and not 40 basis points, as should have been the case.
ICICI Bank has done something along similar lines as well. And this step has essentially negated the cut in the base rate to some extent.

Further, the public sector banks have a problem of huge bad loans, which are piling on. Given this, they are using this opportunity to ensure that they are able to increase the spread between the interest they charge on their loans and the interest they pay on their deposits. This extra spread will translate into extra profit which can hopefully take care of the bad loans that are piling up.

The bad loans will also limit the ability of banks to cut their lending rates. As Crisil Research points out: “High non-performing assets [NPAs] curb the pace at which benefits of lower policy rate are passed on to borrowers. Data shows periods of high NPAs – such as between 2002 and 2004 (when NPAs were at 8.8% of gross advances) – are accompanied by weaker transmission of policy rate cuts. This time around, NPA levels are not as high as witnessed back then, but still remain in the zone of discomfort.”

Another reason banks often give for not cutting interest rates is the presence of small savings scheme which continue to give high interest when banks are expected to cut interest rates. As India Research and Ratings points out: “In the last decade small saving deposit schemes have offered rates between 8-9.3% unrelated to the up-cycle or down-cycle in policy rates. These rates are also politically sensitive since a bulk of this saving is made by elders, farmers and low income groups. In fact in 2009 when repo rates were at a low of 4.75%, PPF and NSC both continued to offer 8% return and in 2012 when the repo rate moved up to 8.5%, PPF offered 8.8% and NSC offered 8.6% return.”

Nevertheless, this time around banks have cut interest rates on their one year deposits by 130 basis points. This is more than the 125 basis points repo rate cut carried out by the RBI during the course of this year.

A more informed conclusion could have been drawn here if there was data available on the kind of interest rate cuts that banks have carried out on their fixed deposits of five years or more. This would have allowed us to carry out a comparison with small savings scheme which typically tend to attract long term savings.

Long story short—EMIs and interest rates fall more on the front pages of business newspapers than they do in real life.

The column originally appeared on The Daily Reckoning on October 8, 2015

Government of India must stop hoarding food


Vivek Kaul

Food inflation has been an issue of huge concern over the last few years. In a recent report titled What a waste! Crisil Research points out that “food inflation has averaged 8.1% in the last decade, and over 10% in recent times.”
This when agricultural growth has been robust and our granaries continue to overflow. Agricultural growth over the last decade stood at 3.6% per year, in comparison to 2.9% per year, in the decade before that. Hence, the conventional argument that food inflation is a result of not enough supply in comparison to demand, doesn’t totally hold.
The Food Corporation of India (FCI) puts out a number indicating its food grains stock every month. As on June 1, 2014, the food grain stock, which includes rice, wheat, unmilled paddy and coarse grains, stood at 74.8 million tonnes. At the beginning of June 2008, the stock had stood at 36.4 million tonnes.
This indicates that the government through FCI has bought and hoarded more and more of rice and wheat produced in the country. In a May 2013 research report titled Buffer Stocking Policy in Wake of NFSB (National Food Security Bill) written by Ashok Gulati and Surbhi Jain of the Commission for Agricultural Costs and Prices(CACP) it was estimated that anywhere between 41-47 million tonnes, would be a comfortable level of buffer stocks.
This would be enough to take care of the subsidised grain that needs to be distributed to implement the food security scheme. At the same time it would also take care of the strategic reserves that the government needs to maintain, to be ready for a drought or any other exigency.
The current level of food grains with the FCI is significantly more than 41-47 million tonnes. One impact of this is that the government spends money in buying the “extra grain” which it does not require. This adds to the government expenditure and in turn the fiscal deficit. The fiscal deficit is the difference between what a government earns and what it spends. The CACP authors had estimated that an excess stock of 30-40 million tonnes would cost the government anywhere between Rs 70,000 to Rs 92,000 crore.
The main reason for this “extra procurement” is the fact that the Congress led UPA government kept increasing minimum support price(MSP) of food grains over the years, at a fast pace. In 2005-2006, the MSP for common paddy(rice) was Rs 570 per quintal. By 2013-2014 this had shot up to Rs 1310 per quintal, an increase in price of around 11% per year. In comparison, between 1998-1999 and 2005-2006, the MSP of rice had increased at the rate of 3.8% per year.
In case of wheat the MSP has gone up by 14% per year between 2005-2006 and 2013-2014. In comparison, between 1999-2000 and 2005-2006, the price had gone up by 4% per year.
In fact, the decision to increase the MSP was totally random. A report released by the Comptroller and Auditor General in May 2013 pointed out that “No specific norm was followed for fixing of the Minimum Support Price (MSP) over the cost of production. Resultantly, it was observed the margin of MSP fixed over the cost of production varied between 29 per cent and 66 per cent in case of wheat, and 14 per cent and 50 per cent in case of paddy during the period 2006-2007 to 2011-2012.”
Other than the government expenditure shooting up, the rapid increase in MSP has led to more and more food grains landing up with the government. The FCI does not have enough storage capacity for this grain. This is one reason why newspapers frequently carry pictures of food grains rotting, lying in the open. “Between 2005 and 2013, close to 1.94 lakh tonnes of food grain were wasted in India, as per FCI’s own admission in the Parliament,” the Crisil report points out. Rice formed 84% of the total damage.
Further, the excess procurement has also led to high inflation, as a lower amount of rice and wheat have landed up in the open market. The CAG report points out that in 2006-2007, 63.3 million tonnes of rice landed in the open market. By 2011-2012, this had fallen by a huge 23.6% to 48.3 million tonnes. The same is true about about wheat as well, though the drop is not as pronounced as it is in the case of rice. In 2006-2007, the total amount of wheat in the open market stood at 62.1 million tonnes. By 2011-2012, this had dropped to 61.4 million tonnes.
Also, with MSPs going up every year at a rapid rate, “the cropping pattern” the Crisil report points out “has been biased towards food grains like rice and wheat, and have led to excessive production”.
Given this, one way of bringing down food inflation is the government releasing stocks of rice and wheat into the open market. One problem here can be that the procurement is concentrated in a few states. In case of wheat these states are Punjab, Haryana and Madhya Pradesh. And in case of rice, these states are Andhra Pradesh, Chattisgarh and Punjab. Hence, stocks will have to be moved from these parts of the country to other parts. More than that the government needs to stop procuring more than what it needs to run its various programmes. This will be beneficial from the fiscal deficit front as well as help moderate inflation.
This becomes even more important given that the India Meteorological Department expects the monsoon to be below normal at 93 per cent of the long period average. In this scenario, the production of grains is expected to take a hit. If the government continues with excess procurement, less grains will land up in the open market and push prices further up.
Also, when it comes to production of food products like milk, milk products, egg, fish and meat, supply has been lagging demand. The production has risen only at the rate of 3-4% between 2009-2010 and 2012-2013, whereas the price has risen at the rate of 14-15%, the Crisil report points out. This needs to be addressed.
When it comes to fruits and vegetables, the Agricultural Product and Market Committee(APMC) Act was passed to help farmers. Instead, it has made them vulnerable to traders backed by political parties. The huge increase in price of onion last year, despite a small fall in production is an excellent example of the same. The trader cartels need to be broken down.
These steps need to be taken if food inflation has to be controlled in the time to come.

 The article originally appeared in The Asian Age/Deccan Chronicle on June 17, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected]