India’s Ecommerce Ponzi Scheme Has Started to Unravel

flipkartA spate of newsreports in the recent past clearly show that Indian ecommerce companies are in trouble.

A newsreport on Moneycontrol.com points out: “With an aim to cut costs, struggling e-commerce firm Snapdeal is likely to downsize its team by around 1,300 employee.” This is around one-third of the company’s total workforce of 4,000 employees.

On the other hand, Flipkart has shutdown its courier service and hyperlocal delivery project, less than a year after launching it. There are other examples as well. The question is why are companies doing this? They are trying to cut down their costs and at the same time conserve on all the money they have raised from investors.

Over and above this, investors have made a spate of mark-downs to their investments in these firms. A January 27, 2017, newsreport on Reuters points out that Fidelity Investments has marked down its investment in Flipkart by around 36 per cent. In December 2016, Morgan Stanley, had marked down its investment in Flipkart by 38 per cent.

The Japanese investor Softbank recently marked down the combined value of its shareholding in Ola and Snapdeal by $475 million. What does all this mean? It essentially means that these investors do not accept these ecommerce firms to be as successful as they expected them to be in the past. And given this, they have been writing down the value of their investments.

In a column, I had written early last year I had called Indian ecommerce firms a Ponzi scheme. Of course, this had led to a lot of abuse on the social media and I was told that I do not understand the business model of these firms. I wrote what I did because I understood the business model of these firms. Allow me to explain.

A look at the profit and loss numbers of these firms will tell you that the losses of these firms go up at the same time as their revenue.  Take the case of the market major Flipkart. As a report in the Business Standard points out, for the financial year ending March 31, 2016, the losses of the firm stood at Rs 2,306 crore. The company’s losses for the year ending March 31, 2015, had stood at Rs 1,096 crore. Where did the revenue of the firm stand at? It jumped from Rs 772.5 crore to Rs 1,952 crore, during the same period.

Or take the case of Snapdeal run by Jasper Infotech Private Ltd. A report in the Mint points out that for the financial year ending March 31, 2016, the losses of the firm stood at Rs 3,316 crore. For the financial year ending March 31, 2015, the losses had stood at Rs 1,328 crore. During the same period, the revenue of the firm increased from Rs 933 crore to Rs 1,457 crore.

What sort of a business model is this—where the losses of a company go up at the same time as its revenue? In fact, in case of Snapdeal, the losses have gone up at a much faster rate than its revenue.

What explains this basic disconnect? As Gary Smith writes in Standard Deviations—Flawed Assumptions, Tortured Data and Other Ways to Lie With Statistics: “A dotcom company proved it was a player not by making money, but by spending money, preferably other people’s money… One rationale was to be the first-mover by getting big fast… The idea was that once people believe that your web site is the place to go to buy something, sell something, or learn something, you have a monopoly that can crush competition and reap profits.”

What was true about American dotcoms is also true about Indian ecommerce companies. This isn’t surprising given that many investors in Indian ecommerce firms are American.

I discovered Flipkart one day in 2009. Back then it was simply an online bookstore. It had a reasonably good collection of books. It even had books which bookstores did not. And the deliveries were on time.

What else did one want? Discounts. It had good discounts on offer as well. Hence, out went the bookstore and in came Flipkart. The loyalty was to discounts and nothing more. Sometime later, when other websites like Homeshop18 and even Amazon, started offering higher discounts, I moved to ordering from these websites.

Nevertheless, one did wonder, how would these websites ever get around to making money, given the huge discounts that they offered. The way businesses run traditionally it never makes any sense to sell a product below the cost all the time, because that way the business is never going to make any money.

But these websites did not fit into the traditional way of doing things. At least, that is way they thought. The best way to explain this is through the example of a telephone. As James Evans and Richard L. Schmalensee write in Matchmakers: The New Economics of Multisided Platforms: “A telephone was useless if nobody else had one. Even Bell and Watson started with two. A telephone was more valuable if a user could reach more people.”

The point being that more the number of people who had a telephone, more the number of people who would want to have a telephone. The economists call this the phenomenon of the direct network effect. This essentially means that more the number of people who are connected to any particular network, the more valuable it is to people who are already a part of it.

Take the case of app-based cab services. When they launched, they offered rock bottom rates. This was done to attract customers. Once customers came on board, it was easy to attract more and more drivers on to the network as well. And over a period of time, the price of these app based services has gone up.

Of course, it is not easy as I make it sound. But that is the basic logic. Then there are apps which deliver food from restaurants. They also offered discounts initially in order to build a critical mass of customers to be able to attract good restaurants on the platform.

As economist John Kay writes in Everlasting Last Bulbs—How Economics Illuminates the World: “The company that is first to create the largest network denies access to competitors and establishes an unassailable monopoly…Connectedness is vital, and it is best to be connected to the largest network.”

So, the ecommerce game is centred around building a monopoly and cashing in on it. As Ray Fisman and Tim Sullivan write in The Inner Lives of Markets in the context of network externality: “The bigger a company gets, the more valuable it is to each successive customer, there’s a huge premium on expanding your customer base.”

And this explains the discount led model. In case of Flipkart, the discount led model was first offered on books to build a critical mass of customers, and then the company gradually got into selling many other products. The hope was that once the consumer was comfortable buying books from the website, he would become comfortable buying other products as well, over a period of time. The logic worked on the supply side as well, as more and more vendors got comfortable selling online, more vendors came in.

Of course, the discount led model leads to losses. Hence, any company following this model, needs money from investors to keep running. And this is where the structure of Indian ecommerce companies becomes similar to that of a Ponzi scheme.

A Ponzi scheme is essentially a financial fraud in which investment is solicited by offering very high returns. The investment of the first lot of investors is redeemed by using the money brought in by the second lot. The investment of the second lot of investors is redeemed by using the money brought in by the third lot and so on.

The scheme continues up until the money being brought in by the new investors is greater than the money being redeemed to the old investors. The moment the money that needs to be redeemed becomes greater than the fresh money coming in, the scheme collapses.  How does this apply in case of Indian e-commerce companies?

Indian ecommerce companies have managed to survive because of investors bringing in fresh money into the scheme at regular intervals. It is worth mentioning here that every time investors bring in more money, they bring it in at a higher valuation. This essentially means that the price at which shares of the company are sold to the investors are higher than they were the last time around. This increases the market capitalization of the company.

This increase in market capitalization comes about because the company has managed to increase its revenue. As long as the money being brought in by the investors keeps subsidising the losses being accumulated by the e-commerce firms, these firms will keep running. The moment this changes, the firms will start to shut-down. The structure of the Indian e-commerce companies is that of a classic Ponzi scheme.

Nevertheless, as we have seen earlier in this column, this increase in revenue typically comes at the losses increasing as well. This is a fact that investors of these firms have started to realise as well. And that is why they have marked down the value of their investments.

An investor who is marking down his investment is unlikely to invest more money into the firm. If he actually goes about investing more money in the firm, then he is likely to do it at a much lower valuation. Given this, the Indian Ecommerce Ponzi scheme is now unravelling. The trouble is that everyone wants to be build a monopoly. But everyone cannot be a monopoly.

As Smith writes in the context of the American dotcom bubble: “The problem is that, even if it is possible to monopolize something, there were thousands of dotcom companies and there isn’t room for thousands of monopolies. Of the thousands of companies trying to get big fast, very few can ever be monopolies.”

This basic logic applies to the Indian ecommerce as well. And given this, if fresh investor  money stops coming into these firms, as it has in many cases, these companies will soon start going bust.

To conclude, it’s time we got ready for the ecommerce bloodbath.

The column was originally published on Equitymaster on February 15, 2017

Why Indian E-commerce Is A Ponzi Scheme

flipkartIt is that time of the year when the business media is publishing the financial results of Indian ecommerce companies for the financial year 2014-2015(i.e. the period between April 1, 2014 and March 31, 2015). The numbers are being taken from the filings that the ecommerce companies have made with the Registrar of Companies(RoC).

And the results make for a very interesting reading. As can be seen from the accompanying table compiled from various media reports, the losses of the major ecommerce companies have gone up multiple times during the course of the year.

It needs to be stated here upfront that it is difficult to estimate the exact numbers of the ecommerce companies given that they have complex holding structures as regulations in India currently do not allow foreign direct investment in online retail, but allow it in case of an online marketplace.

chart

The combined losses of the five companies in the table stood at Rs 5524 crore in 2014-2015. In 2013-2014, the losses had stood at Rs 1338.1 crore. This is a jump of a whopping 313%. How does their combined revenue number look? In this case a direct comparison cannot be made given that the revenue numbers of Snapdeal for 2014-2015 are not available.

As a recent news-report in the Mint newspaper points out: “Snapdeal reported a loss of Rs.1,328.01 crore for the same year, compared with Rs.264.6 crore in the previous year, RoC documents show. It didn’t disclose revenue numbers.”

Hence, we will have to adjust for Snapdeal numbers before we compare revenue earned by the companies with their accumulated losses. The revenue for 2014-2015 for four companies other than Snapdeal stood at Rs 11,827 crore. The revenue for 2013-2014 for these four companies had stood at Rs 3,445.8 crore. This is a jump of 243% over the course of one year.

In the normal scheme of things a jump of 243% in revenue in one year would have been deemed to be fantastic, but the losses of these companies have gone up at a much faster rate. In 2013-2014, the losses of the four companies other than Snapdeal stood at Rs 1073.5 crore. In 2014-2015, the losses had jumped by a whopping 291% to Rs 4,196 crore.

Hence, a 243% jump in revenues has been accompanied by a 291% jump in losses. This analysis is skewed to some extent given the huge size of Flipkart in the sample. If we had known Snapdeal revenue numbers for 2014-2015, the results would have been more robust.

Nevertheless, even the small companies in the sample, show the same trend as the broad trend is. Take the case of Paytm. In 2013-2014, the company made a profit of Rs 5 crore on a revenue of Rs 210 crore. In 2014-2015, the revenue jumped to Rs 336 crore and the losses jumped to Rs 372 crore. Shopclues also showed a similar trend. The revenue of the company went up by 155% between 2013-2014 and 2014-2015, whereas the losses went up by 163%.

What sort of a business model is this—where the losses of a company go up at a faster rate than its revenue? The answer lies in the fact that the Indian ecommerce companies have adopted a discount model in order to lure customers. This means selling products at a loss in order to build a customer base.

This strategy of acquiring customers has been directly copy-pasted from what many American ecommerce companies did during the dotcom boom towards the turn of the century.  As Gary Smith writes in Standard Deviations—Flawed Assumptions, Tortured Data and Other Ways to Lie With Statistics: “A dotcom company proved it was a player not by making money, but by spending money, preferably other people’s money…One rationale was to be the first-mover by getting big fast…The idea was that once people believe that your web site is the place to go to buy something, sell something, or learn something, you have a monopoly that can crush competition and reap profits.”

The major Indian ecommerce companies seem to be following a similar strategy of trying to build a monopoly by offering products on substantial discounts. The trouble with this strategy is that it needs a lot of money. Up until now, the Indian ecommerce companies have managed to survive because international hedge funds and private equity investors have made a beeline for investing in them.

With returns from financial securities all over the world drying up over the last few years, Indian ecommerce companies have offered an iota of hope. The trouble is that every reasonably big Indian ecommerce company with access to funding seems to be following the same strategy of offering discounts and wanting to build a monopoly. And once they are there, they hope to cash in.

Having said that, the current structure of the Indian ecommerce companies is akin to a Ponzi scheme. A Ponzi scheme is essentially a financial fraud in which investment is solicited by offering very high returns. The investment of the first lot of investors is redeemed by using the money brought in by the second lot.

The investment of the second lot of investors is redeemed by using the money brought in by the third lot and so on.

The scheme continues up until the money being brought in by the new investors is greater than the money being redeemed to the old investors. The moment the money that needs to be redeemed becomes greater than the fresh money coming in, the scheme collapses.

How does this apply in case of Indian ecommerce companies? Up until now the companies have managed to survive because of investors bringing in fresh money into the scheme at regular intervals. It is worth mentioning here that every time investors bring in more money, they bring it in at a higher valuation.

This essentially means that the price at which shares of the company are sold to the investors are higher than they were the last time around. This increases the market capitalization of the company.

This increase in market capitalization comes about because the company has managed to increase its revenue. But as we have seen earlier in this column, this increase in revenue typically comes at the losses increasing at a much faster rate. I wonder why all these fancy investors do not take something as basic as this into account?

Having said that, as long as this money keeps coming in and is greater than the losses being accumulated by the ecommerce firms, these firms will keep running.

The moment this changes, the firms will start to shut-down. The structure of the Indian ecommerce companies is that of a classic Ponzi scheme. In fact, a news-report in The Economic Times suggests that FabFurnish, a furniture retailer, is likely to shutdown given that its German investor does not want to burn any more money to finance its losses.

The trouble is that everyone wants to be build a monopoly. But everyone cannot be a monopoly. As Smith writes in the context of the American dotcom bubble: “The problem is that, even if it is possible to monopolize something, there were thousands of dotcom companies and there isn’t room for thousands of monopolies. Of the thousands of companies trying to get big fast, very few can ever be monopolies.” While the word thousands does not really apply in the Indian case, the overall logic still remains the same i.e. everyone cannot be a monopoly.

This means that many of today’s fledging ecommerce companies will shutdown in the years to come as investors pull the plug. In fact, the companies with the deepest pockets are likely to survive. Meanwhile, dear reader, enjoy the discounts until they last.

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

The column originally appeared on SwarajyaMag on January 28, 2016

Why smart people fall for Ponzi schemes

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Sometime back a friend called and had a rather peculiar question. He wanted to know how he could go about stopping one of his friends from peddling a Ponzi scheme.

This was a rather tricky question. Just explaining to someone selling a Ponzi scheme that he is selling a Ponzi scheme, does not really work. The first question I asked my friend was how was his friend doing in life? “He is doing well for himself,” said my friend with a chuckle. “He works in a senior position with a corporate and has managed to sell the scheme to at least ten people in the housing society that he lives in.”

“If he is working at a senior position, why is he doing this?” I asked my friend, and immediately realised that I had asked a rather stupid question. “I was hoping you would be able to answer that,” my friend replied.

This column is an outcome of that conversation.

Over the last ten years of writing on Ponzi schemes I have come to the realisation that many people who sell and in the process invest in Ponzi schemes are not just victims of greed or a sustained marketing campaign, as is often made out to be.

There is much more to it than that. Many individuals selling and investing Ponzi schemes (like my friend’s friend) come from the upper strata of the society, are well educated and know fully well what they are doing. In case of my friend’s friend he was selling a multilevel marketing scheme for which the membership fee is more than Rs 3 lakh. So, the scheme is clearly aimed at the well to do.

On becoming a member you are allowed to sell products, some of which cost as much as a lakh. Of course, you will also be making new members as well. The bulk of the membership fee paid by the new members you make, will be passed on to you. Hence, the more people you get in as members, the more money you make. Selling products is just incidental to the entire thing, given that a membership costs more than Rs 3 lakh.

This is a classic Ponzi scheme in which money being brought in by the new investors (through membership fee) is being used to pay off old investors (who had already paid their membership fee), with the business model of selling products providing a sort of a façade to the entire thing.

So, the question is why does the smart lot fall for Ponzi schemes? As John Kay writes in Other People’s Money—Masters of the Universe or Servants of the People: “Even if you know, or suspect, a Ponzi scheme, you might hope to get out in time, with a profit. I’ll be gone, you’ll be gone.”

People feel that the money will keep coming in. Or what the financial market likes to call ‘liquidity,’ won’t dry up. And this is the mistake that they make.
Kay defines liquidity as the “capacity of the supply chain to meet a sudden or exceptional demand without disruption…This capability is achieved…in one or both of two ways: by maintaining stocks, and by the temporary diversion of supplies from other uses.”

Kay in his book compares the concept of liquidity to the daily delivery of milk in the city of Edinburgh in Scotland where he grew up. As he writes: “In the Edinburgh of fifty years ago fresh milk was delivered everyday…At ordinary times our demand for milk was stable. But sometimes we would have visitors and need extra milk. My mother would usually tell the milkman the day before, but if she forgot, the milkman would have extra supplies on his float to meet our needs. Of course, if all his customers did this, he wouldn’t have been able to accommodate them.”

What is the important point here? That people trusted the milkman to deliver every morning. And given that they did not stock up on milk, more than what was required on any given day. If the trust was missing then the system wouldn’t have worked.

Take the case of how things were in the erstwhile Soviet Union. As Kay writes: “In the Soviet economy there was no such confidence, and queues were routine, not just because there was an actual insufficiency of supply – though there often was – but because consumers would rush to obtain whatever supplies were available.”

And how does that apply in case of Ponzi schemes? As I mentioned earlier, the individual selling Ponzi schemes feel confident that the money will keep coming in. Those they sell the scheme also become sellers. And for the Ponzi scheme to continue, the new lot also needs to have the same confidence.

In the milk example shared above, if people of Edinburgh had started hoarding milk, the liquidity the system had would have broken down. The confidence that milk would be delivered every day kept the system going. Along similar lines, the confidence that money will keep coming into a Ponzi scheme, gets smart people into it as well.

Of course, this confidence can change at any point of time. And if a sufficient number of people stop feeling confident, then the scenario changes. The money coming into the Ponzi scheme stops and the moment the money coming into the scheme becomes lesser than the money going out, it collapses. So that’s the thing with liquidity, it is there, till it is not there.

In my friend’s friend case, members down the line would stop making more members. Also, members who had bought the membership from my friend’s friend are likely to turn up at his doorstep and demand their money back.

And given that he has told membership to many people in his housing society, he can’t just get up and disappear, given that he is essentially not a scamster. He is a family man with a wife, children and parents, who stay with him.

Hence, he will have to refund them, if he has continue living in the housing society in a peaceful environment. How will he do that? Let’s go back to the definition of liquidity as explained above. Liquidity is maintained by “by maintaining stocks, and by the temporary diversion of supplies from other uses.” So my friend’s friend can pay up from the money he has already accumulated by selling these Ponzi schemes. If that is not enough, he can dip into his savings. And if even that is not enough, he can hopefully take the money being brought in by the new members (if at all there are people like that) and hand them over to the members demanding their money back.

Of course, by doing this he will only be postponing the problem, given that he would have to later deal with the new members.

Long story short—he is screwed!

The column originally appeared on The Daily Reckoning on Oct 13, 2015

The Great Indian banking Ponzi scheme

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One of the themes that I have regularly explored in The Daily Reckoning newsletters is the mess that the Indian banking sector currently is in. This newsletter is another one in the series.

The RBI Financial Stability Report released in June earlier this year pointed out: “Five sub-sectors, namely, mining, iron & steel, textiles, infrastructure and aviation, which together constituted 24.8 per cent of the total advances of scheduled commercial banks, had a much larger share of 51.1 per cent in the total stressed advances. Among these five sectors, infrastructure and iron & steel had a significant contribution in total stressed advances accounting for nearly 40 per cent of the total.”

Within the infrastructure sector, the power sector is a big defaulter. Loans to the power sector form around 8.3% of the total loans. But at the same time they form around 16.1% of the stressed advances.

The stressed advances or loans are arrived at by adding the gross non-performing assets (or bad loans) plus restructured loans divided by the total assets held by the Indian banking system. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan by increasing the tenure of the loan or lowering the interest rate.

So what would typically happen in such a scenario? Banks would go slow on lending to sectors that have been defaulting on their loans. But is that really the case? The sectoral deployment of credit data released by the Reserve Bank of India (RBI) earlier this month suggests otherwise. This despite the fact that banks claim every quarter that they continue to stay away from the sectors that have given them pain in the past.

People may not always tell the right story but numbers do. And here are the numbers. The RBI sectoral deployment data suggests that between July 2014 and July 2015 banks lent a total of Rs 1,20,900 crore to industry as a whole. The lending to industry went up by 4.8%, in comparison to 10.2% growth between July 2013 and July 2014.

The situation gets even more interesting when we take a closer look at the numbers. The bank lending to the infrastructure sector between July 2014 and July 2015 grew by Rs 71,600 crore. Within the infrastructure sector lending to the power sector grew by Rs 59,400 crore.

Lending to the iron and steel sector grew by Rs 27,100 crore during the course of the year. Loans to the iron and steel sector form around 4.5% of the total loans and 10.2% of the total stressed advances.

What does this tell us? In the last one year banks gave Rs 98,700 crore of the Rs 1,20,900 crore that they lent to industry to the two most troubled sectors of infrastructure and iron and steel. This means that 81.6% of all industrial lending carried out by banks in the last one year went to the two most troubled sectors of infrastructure and iron and steel.

These sectors form around 19.5% of the total lending carried out by banks and 40% of their stressed assets. The overenthusiasm of banks to lend to these sectors comes even after the RBI in the Financial Stability Report had raised a red flag.

The report had warned that the “the debt servicing ability of power generation companies[which are a part of the infrastructure sector] in the near-term may continue to remain weak given the high leverage and weak cash flows. Banks, therefore, need to exercise adequate caution while dealing with the sector and need to continue monitoring the developments very closely.”

With regard to the iron and steel sector the report had said that “the sector holds very good long term prospects, though it is currently under stress, necessitating a close watch by lenders.” But the July numbers on the sectoral deployment of credit clearly suggest that banks are not listening to the RBI.
What does this really mean? By lending more and more money to sectors which are in trouble, banks are essentially kicking the can down the road.

The banks are giving new loans to companies operating in these troubled sectors so that they can repay their old loans. They are effectively running a Ponzi scheme. A Ponzi scheme is essentially a fraudulent investment scheme where money being brought in by new investors is used to pay off old investors.
Over and above this conversations I have had with some industry insiders I have come to know that banks(in particular public sector banks) have been using the 5/25 scheme in order to postpone dealing with the bad loans issue, in the hope that these loans will become viable in the years to come.

The 5/25 scheme allows banks to extend the loans given to infrastructure projects to up to 25 years while refinancing them every five to seven years. As a December 2014 newsreport in the Mint newspaper points out: “Banks were typically not lending beyond 10-12 years. As a result, cash flows of infrastructure firms were stretched as they tried to meet shorter repayment schedules.”

In fact when the scheme was first introduced it was available only for new projects. However, in December 2014, it was also extended to existing projects as well. Banks were allowed to increase the repayment tenure for companies which had borrowed money for infrastructure projects and come up with fresh amortisation schedules for repayment of loans.

Such an increase in the tenure of repayment would not be treated as a restructuring of assets. An increase in tenure brought down the amount of money that the companies had to pay during the course of a year, in order to repay the loan. And this increased their chances of continuing to repay the loan.

This 5/25 scheme is also available for projects lending against which has already been classified as a restructured asset (i.e. its repayment schedule has already been extended or the interest rate has been lowered). When such a loan is brought under the 5/25 scheme it continues to be classified as a restructured asset up until the project gets upgraded on the satisfactory servicing of the loan.

RBI’s rationale behind extending the 5/25 scheme to existing projects was that that instead of giving up on an asset under stress, if efforts were made to make it viable, then the loan could be paid back and therefore the pressure of bad loans could be eased.

As RBI governor Raghuram Rajan said on August 4, 2015, while addressing a press conference: “We have said that there is no problem to lend to a project even if it is a non-performing asset, so long as it has done something to bring the project back on track and not for evergreening the loan.” But is that really the way banks also look at it?

Rajan further said in a speech on August 24, 2015: “To deal with genuine problems of poor structuring, it has allowed bankers to stretch repayment profiles…to infrastructure and the core sector (the so-called “5/25” rule), provided the project has reached commercial take-off, has a genuinely long commercial life, and the value of the NPV of loans is maintained. RBI is undertaking periodic examination of randomly selected “5/25” deals to ensure they are facilitating genuine adjustment rather than becoming a back-door means of postponing principal payments indefinitely.”

I sincerely hope that RBI is carefully examining the 5/25 loans. As Rajan said, the RBI making it “easy for banks to “extend and pretend”, is not a solution.” I agree.

The column originally appeared in The Daily Reckoning on Sep 11, 2015

Why real estate Ponzi scheme will continue despite new Real Estate Bill


On April 7, 2015, the union cabinet cleared the Real Estate (Regulation and Development) Bill. The Bill essentially mandates that every state needs to set up a Real Estate Regulatory Authority (RERA), to protect consumer interests.
Every commercial as well as residential real estate project needs to be compulsorily registered with the RERA of the concerned state. Real estate companies need to file project details, design and specifications, with the concerned RERA. They need to put up details concerning the approvals from various authorities regarding the project, the design and the layout of the project, the brokers selling the project etc., on the RERA’s website.
Consumers will be able to check these details on the website of the real estate regulator. Further, only once a project is registered with the RERA will it be allowed to be sold. Also, like is the case currently, a real estate company will not be able to go about arbitrarily changing the design of the project midway through the project. In order to do this the company will need approval of two thirds of the buyers.
If the real estate company makes incorrect disclosures or does not follow what it has stated at the time of filing the project with the RERA, it will have to pay a penalty. There are other provisions also that seek to protect consumer interests. Real estate companies will have to clearly state the carpet area of the home/office they are trying to sell, instead of all the fancy jargons that they come up with these days. Further, the bill allows buyers to claim a refund along with interest, in case the real estate company fails to deliver.
So on paper the bill actually looks great. But there is one provision that essentially makes all these provisions meaningless in a way. The Bill requires real estate companies to compulsorily deposit half of the money raised from buyers for a particular project into a monitorable account. This money can then be spent only for the construction of that project against which the money has been raised from prospective buyers.
This is an improvement from the way things currently are. The way things currently work are—a real estate company launches a project, collects the money and then uses that money to do what it feels like. This might mean repaying debt that it has accumulated or diverting the money to complete the projects that are pending. Given this, at times there is no money left for the project against which the money has been raised. In order to get the money for that, another project will have to be launched. Meanwhile the prospective buyers are stuck.
Developers love launching new projects simply because it is the cheapest way to raise money. Money from the bank or the informal market, means paying high interest. Hence, they raise money for the first project and use it to pay off debt or the interest on it. To build homes under the first project, a second project is launched. Money from this is then used to build homes for the first project.
Now, to build homes promised under the second project, a third project is launched and so the story goes on. In the process, all the buyers get screwed and the builder manages to run a perfect Ponzi scheme. A perfect Ponzi scheme is one where money brought in by the newer investors is used to pay off older investors. In this case money brought in by the newer buyers is used to build homes for the older buyers.
The Real Estate Bill seeks to stop real estate companies from running such Ponzi schemes. As explained above, half the money raised for a particular project needs to be deposited in a monitorable bank account and be spent on the project against which the money has been raised.
The thing is when the Bill was first presented in the Parliament in 2013, the real estate companies had to deposit 70% of the money raised against a particular project in a monitorable account and spend that money on that particular project.
Between then and now the real estate lobby has been able to dilute the 70% level to 50%. What this means that the real estate companies can still use 50% of the money raised against a particular project for other things. And this will essentially ensure that the real estate Ponzi scheme will continue.
Real estate companies will continue to launch new projects to raise money and use half of that money for things other than building the project for which they have raised the money for.
Also, this provision will allow the real estate companies to continue to hold on to their existing inventory and not sell it off at lower prices in order to pay off their debt, given that they can continue to raise money by launching a new project.
The question to ask here is why should a ‘new’ regulation allow money being raised for a particular project to be diverted to other things? It goes totally against the prospective buyers who are handing over their hard earned money(or taking on a big home loan) to the real estate company, in the hope of living in their own home.
A possible answer lies in the fact that if the government had regulated that the money raised for a project should used to build that project, it would have closed an easy way that the real estate companies have of raising money. This would have ultimately led to real estate prices coming down. And any crash in real estate prices would have hurt politicians who run this country, given that their ill-gotten wealth is stashed in real estate.

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

The column originally appeared on Firstpost on Apr 21, 2015