An Open Letter to Bitcoin Bhakts

Vo intizār thā jis kā ye vo sahar to nahīñ
— Faiz Ahmed Faiz.

A couple of days back I wrote a long piece on bitcoin. As expected the backlash was huge, though a couple of people did engage very nicely and in a fact-driven way (You know who you are, so, thanks a tonne for that).

But a bulk of the response from the bitcoin believers was like we know everything about bitcoin and this guy doesn’t know what he is talking about. Of course, they didn’t say this in as polite a way as I am putting it here (or as one believer put it, it was 5,100 words of potty).

In this piece I wanted to list out a random list of points which I have been thinking about over the last couple of days since I published the bitcoin piece. Some of these points have got to do with investing in general and some with bitcoin in particular. Of course, there are points about the bhakts, the bitcoin bhakts, as well.

The conclusion at the end of this piece is the same as the last bitcoin piece, which is that, the life of bitcoin started with an ambition to become a cryptocurrency which wanted to replace the global paper money system. But it has ended up becoming an object of pure speculation and nothing else. (I can already see the bitcoin bhakts going: good you have mentioned this upfront, we don’t need to read beyond this. Our beliefs are safe).

So, here we go.

1) I had been postponing writing the bitcoin piece for a while now. This was probably my way of coping with the backlash I was expecting once the piece was published. But I am glad that I wrote it. What it told me was that bitcoin bhakts like bhakts in general and investing bhakts in particular, are a petulant lot. You don’t agree with them and they are ready to get you.

In a way it’s like god, religion and parents. My god is the best. My religion is the best. My daddy is the strongest. My mother is the sweetest. And my bitcoin is the best. And if you don’t agree with me then you don’t know anything and you are going to get it from me.

2) A very strong unwavering belief hurts when it comes to investing. I have now spent nearly two decades, starting in 2002, writing about business, economics, finance and investing. And I have seen this sort of behaviour before. When I first started writing about a bubble in real estate, sometime in 2013, I got a similar response from real estate investors all over India, like I have from the bitcoin believers, over the past two days.

Real estate prices in 2013 had been rallying for more than a decade and almost no one was ready to believe at that point of time that they could fall or stagnate for a long period of time. Many didn’t even believe there was a bubble.

In fact, many people still don’t, holding on to their investment in the belief that the happy days of pre 2013 will be back. (Now only if these people knew how to calculate the internal rate of return on any investment, which they clearly don’t). Of course, the reason for holding on to real estate can always be an emotional one as well.

So, yes, the bitcoin bhakts aren’t the first believers. There have been believers before them and there will be believers after them. This time is no different.

3) One response that came over and over again was that this guy (that is me) has no idea what central banks have been up to over the years. They have printed so much money, you know. What is he even talking about. 

Well, to set the record straight, anyone who has followed my writing over the years would know the number of times I have written about money printing and central banks and how it is a bad idea. I have also written three books on this issue. I mean I have almost made a career out of it.

But the more important point here is that just because central banks have been printing money doesn’t mean that the paper money system is going to come to an end  quickly and bitcoin will takeover. This is a great example of lazy thinking, and the fact that the human mind is not built to think through complex multi-dimensional issues. This is bounded rationality at work and the bitcoin bhakts have also become a victim to that.

We all need reasons for doing something and more often than not the reasons are very simplistic. Like the case here. Bitcoin will take over the world because central banks have been printing money and now that I have bought bitcoin I need to firmly believe in this. Really

As I explained in my previous bitcoin piece there is a huge status quo which is a powerful force and which benefits from the paper money system in its present form and they aren’t just waiting there to rollover, once the bitcoin bhakts come attacking.

The paper money system that bitcoin bhakts keep talking about has the American dollar at the heart of it. The world trade happens largely in dollars, giving the United States an enormous exorbitant privilege. While every other country in the world needs to earn dollars, the US can simply print it.

And given this, this is a privilege the United States isn’t really going to let go in a hurry. Why do you think US consumption is around a fourth of the global economy, while the country has only 5% of the world’s population? Which US politician in his or her right mind, is not going to worry about this dynamic?

Yesterday, someone on Twitter, shared a news-item which said that an American Senator was in favour of bitcoin as money. I am sure random American Congressmen support random things. Take the case of former Congressman Ron Paul, who supported gold as money for years on end. That does not mean that the American financial system will move to gold as money. So, we are talking change at a systemic level here, not some random guy supporting some random thing, please understand that.

4) I was also told repeatedly that bitcoin is an anonymised peer to peer network and I was making the mistake of looking at it as a centralised system. Well, that is really rich coming from guys who are buying bitcoin from brokers and giving away all their identity details. The moment you are doing that you are buying a speculative asset and not a future form of anonymised money.

5) When I said that barely anyone accepts bitcoin as a payment, two people wrote to me to say that they did. This is precisely the point I was trying to make. They were the exception that proves the rule.

In fact, as the American journalist James Surowiecki wrote in a recent post on bitcoin: “The blockchain analysis company Chainalysis, for instance, found that in the first four months of 2019, just 1.3% of total transactions involved merchants.”  A bulk of bitcoin payments were used to pay for illicit goods and services like drugs and online gambling. (This is not to say that paper money isn’t used for these things. It is. But then the bulk of payments are for regular everyday transactions).

Also, even with these payments, bitcoin payments form an insignificant part of the overall whole. As Surowiecki writes: “On average, there are now around 325,000 Bitcoin transactions — including trades — per day. There are roughly a billion credit card transactions per day.” Over and above this, there are debit card transactions, cash transactions and digital money transactions, to consider. Bitcoin is nowhere in all this.

This is primarily because the bitcoin system is very slow to process transactions. It can process seven transactions a second. Visa, on the other hand, processes 6,000 transactions a second.

I can go on and on why bitcoin is not a medium of exchange, like a good form of money should be, but I will leave it at this.

6) The main reason why very few businesses accept bitcoin as payment is the volatility of its price, Surowiecki points out. Let’s say a business takes payment in bitcoin. Chances are that the next morning the price falls majorly, then the business can end up with a loss on the transactions it made a day before. (Of course, the price can go up as well… but then this is business not gambling).

The volatility of price comes from the fact that most people buying bitcoin are in it, in order to make a quick buck. They see an asset whose price is going up, they buy it. When they see an asset whose price is going down, they sell out. Of course, there are believers as well.

7) This is an interesting one. I learnt yesterday that you identify a bitcoin bhakt, the moment he says HFSP to you. For all the Boomers out there, HFSP stands for Have Fun Stay Poor. Apparently, this is something that bitcoin bhakts say often when people question their core beliefs. It’s an easy, slightly humorous way to get back without necessarily having to think through what the person questioning their core beliefs is basically trying to say. (It’s all potty you know).

Also, it is important to understand, different people are mentally built differently, when it comes to how they look at money. In my scheme of things return of capital is more important than return on capital when it comes to money and investing. Money has never come easily to me and whatever I have I would rather protect it than take a punt with it. If that means staying poor in the eyes of bitcoin bhakts, then so be it.

But then that shouldn’t stop you from buying bitcoin. If you feel it needs to be a part of your investment portfolio and if you feel that you are okay taking the risk, then please go ahead. It is your hard earned money at the end of the day.

8)  The recent interest shown by hedge fund managers basically should tell everyone very clearly that bitcoin as an object of speculation is now entering the mainstream. Of course, this means that the price of the thinly traded bitcoin can go up even further. So, there might be more money to be made. But then do remember that hedge funds are a mercurial lot. They can go out of a trade much faster than they get into it.

Hence, the oldest cliché in investing, don’t put all your eggs in one basket, applies to bitcoin as well. If you want to speculate, please go ahead and do it. But don’t bet your life on it.

9) Many bitcoin bhakts believe in anarchy when it comes to the money system. They seem to be okay with different forms of cryptocurrencies competing with each other, a few dying in the process and the best ones continuing to exist.

It is important to understand here, that there is a difference between money and mobile phones. While mobile phone brands can keep changing, depending on customer preferences and specifications on offer, the same argument applied to money doesn’t really work.

A major reason for the evolution of standardised fiat paper money lies in the fact that there were too many forms of money going around and this caused needless confusion and built huge costs of doing business into the system. A lot of this standardisation happened through the centuries and made lives easy for business and normal mortals. Of course, there are problems with this system.

10) I also understood something all over again. As the American novelist Upton Sinclair once remarked: “It is difficult to get a man to understand something, when his salary depends on his not understanding it.” When the price of an investment asset is going up at an extremely fast pace, all people can see is that it’s going up, without realising that it’s going up because it’s going up.

To conclude, the life of bitcoin started with an ambition to become a cryptocurrency which wanted to replace the global paper money system. It has now become a speculative asset at best and nothing more.

As The Economist recently put it, rising prices of bitcoin “may be good news for those holding bitcoin that others are piling in, but speculators’ enthusiasm suggests that cryptocurrencies will fall far short of their founders’ lofty aspirations”.

Satoshi Nakamoto, the mysterious inventor of bitcoin, whoever he is, wherever he is, must be a rich man today. Nevertheless, he must be a terribly disappointed man as well.  This wasn’t what he was trying to engineer.

The sad thing as always is, in life, things rarely go as planned.

Kyon Dare Zindagi Mein Kya Hoga
Kuch Na Hoga To Tajruba Hoga.
— Javed Akhtar.

Will the Great Indian Real Estate Bubble Finally Burst? It’s for the Modi Govt to Decide


In a surprise late evening move yesterday, prime minister Narendra Modi told the nation in a TV address, that come midnight, Rs 500 and Rs 1,000 notes will no longer be legal tender.

As I explained in a column published earlier today, one reason for doing this is to tackle the menace of fake notes. The second reason for doing this is to tackle black money.

As I mentioned in the earlier column, the move seems to be inspired from the American dollar as well as the British pound. In the United States, the highest denomination bank note is $100. When it comes to the United Kingdom, the highest denomination bank note issued by the Bank of England is £ 50. In the United States as well as the United Kingdom, the highest denomination note is essentially 50 times the smallest denomination note of one dollar or one pound.

In India, up until now the highest denomination note was Rs. 1,000 and this was 1,000 times the smallest denomination note of Re 1, issued by the ministry of finance. When a currency has notes of higher denomination, it is easier to launder money i.e. store black money, as it takes less space and weighs less as well.

As Ritika Mankar Mukherjee and Sumit Shekhar of Ambit Capital wrote in a recent research note: “For instance, the weight of Rs 1 crore in the form of hard cash rises from 12kgs to 100kgs if the denomination of the sum is changed from 1,000-Rupee notes to 100-Rupee notes.”

Also, Rs 500 and Rs 1,000 form the bulk of the total amount currency notes in the Indian financial system. As per the Reserve Bank of India, the total amount of paper notes in circulation in 2015-2016 amounted to Rs 16.4 lakh crore. Of this, the high denomination notes of Rs 500 and Rs 1,000 amounted to Rs 14.2 lakh crore or a little over 86 per cent. The Rs 500 notes amounted to Rs 7.9 lakh crore whereas Rs 1,000 notes amounted to Rs 6.3 lakh crore.

This basically means that anyone who has black money stored in the form of currency notes is more than likely to have it in the form of Rs 500 and Rs 1,000 notes. Black money is basically money which has been earned and on which taxes have not been paid. As Mukherjee and Shekhar write: “Given that 48% and 39% of the total value of currency in India is in the form of Rs 500 and Rs 1000 notes respectively, discontinuing usage of either of these notes can increase the physical costs and risks of holding black money significantly.”

Given this, anyone who has these notes, must go deposit this money in a bank account or in a post office account. And if the money being deposited is black money then questions are likely to be asked by the income tax department. Hence, that is unlikely to happen, at least not in a direct way.

One repercussion of this move that is being widely talked about is that it will lead to a fall in real estate prices. Typically, real estate throughout the length and breadth of India is bought using black money. A significant part of the payment is made in cash. Either this is black money being used or it is white money being converted into black. Experts are of the view, that the Modi government’s crackdown on black money is likely to lead to real estate prices coming down significantly.

The logic is that with Rs 500 and Rs 1,000 no longer being legal tender, it will become difficult to make the black component of the payment using currency notes. With the cash component becoming difficult to pay, it is expected that the real estate companies and builders will have to cut prices.

Further, the government plans to launch new Rs 500 and Rs 2,000 notes. It will not be so straightforward to exchange the old Rs 500 and Rs 1,000 notes with these new notes, at least that is the feeling that currently prevails.

This is the logic being offered by experts who are forecasting a fall in real estate prices. As Yashwant Dalal, president of the Estate Agents Association of India told The Economic Times: “Property markets will see around 30% correction in prices…Apart from big property markets, tier II and III cities will be worst affected.” Property prices in tier II and tier III cities will fall more because the black component while buying a home is higher in these cities.

Further, as Anuj Puri, chairman and country head, JLL India, told Mint: “We have just witnessed a tremendous step towards increased transparency in the Indian real estate industry…The effects will be far-reaching and immediate, and shake up the sector in no uncertain way.” Rajiv Talwar, CEO of DLF, was a little more direct than Puri when he told The Economic Times: “There is bound to be a downward pressure on prices of everything including real estate.”

How do I see the situation? Given that I have been bearish on real estate for as long as I have been, it would be easy for me to say that prices will crash. But the past data (whatever limited data we have on real estate) doesn’t suggest the same.

So, my feeling is that real estate prices will fall, but whether they will crash or not, depends on how the government reacts to the situation. Allow me to explain.

This is something I had written in the last edition of The Vivek Kaul Letter, but it is worth repeating here. The current financial crisis that the world is dealing with, essentially started once the investment bank Lehman Brothers declared bankruptcy in mid-September 2008. Real estate prices fell across large parts of the world. But India beat the trend.

The question is why did this happen. Why did real estate prices in India not crash? How did India manage to beat a global trend? The answer lies in Figure 1.

                                Figure 1: Bank lending to commercial real estate (in Rs. Crore) Bank lending to commercial real estate (in Rs. Crore)

The Figure 1, plots the total loans given by banks to commercial real estate, essentially, builders or real estate companies, which make and sell homes, in the period following the start of the financial crisis in late 2008 and early 2009. In the aftermath of the financial crisis, real estate companies in India were also under a lot of pressure. Loans had to be repaid. At the same time the buyers had simply disappeared from the market.

To attract buyers, builders did start to cut prices. Nevertheless, that soon came to a stop. Look at Figure 1. There is a huge jump in lending between January 2009 and February 2009. In January 2009, the total bank lending to commercial real estate stood at Rs. 78,401 crore. At the end of February 2009, the total bank lending to commercial real estate stood at Rs. 90,765 crore. During the period of just one month, lending to real estate went up by Rs. 12,364 crore or 15.8 per cent.

This, when the total lending by banks (non-food credit) between January 2009 and February 2009 went up by Rs. 26,380 crore. Hence, lending to commercial real estate by banks, formed close to 47 per cent of the total lending carried out by banks during the month.

This was a huge anomaly. It is safe to say that this was a bank-sponsored bailout of the real estate sector. If this bailout had not been carried out real estate companies would have had to cut prices majorly to sell homes, to be able to earn enough money to repay the bank loans that they had taken on. Chances are they would have defaulted on some of these loans as well.

The Indian banks managed to avoid this scenario by lending fresh money to real estate companies. The fresh loans were used by the real estate companies to repay their old loans. If these fresh loans hadn’t come through then the real estate companies would have had to cut home prices, so as to be able to sell homes and earn enough money to repay those loans. And India’s real estate bubble would have ended in 2009.

Look at Figure 2. It basically plots the growth in bank lending to commercial real estate over the years. So, in June 2011, the growth rate was at 23.2 per cent. This means that the growth in bank lending to real estate companies between June 2010 and June 2011, stood at 23.2 per cent. All other data points have been plotted in a similar way.

                              Figure 2: Growth in lending to commercial real estate (in %)Growth in lending to commercial real estate (in %)

It is clear from Figure 2 that the growth in bank lending to real estate companies simply exploded in the aftermath of the financial crisis. In fact, it just went up vertically. Zoom!

And this explains, why the real estate prices in India did not fall in the aftermath of the financial crisis. Further, this also tells us why India beat the global trend of falling real estate prices. Of course, perpetual reasons like black money finding its way into real estate, were also there.

Further, the law of demand does not work in the real estate market. In a normal market, when prices go up, people buy less of that thing. In the real estate market, as prices go up, more and more people enter the market (as is the case with the stock market as well). This is what happened post 2009 in India. Rising real estate prices brought the buyers back into the market and the real estate bubble got a new lease of life.

In fact, it is clear from Figure 2, that the growth in bank lending to real estate companies goes through some sort of a cycle. Are these lending cycles linked to the rate of increase of real estate prices? The trouble is that there is very little data available on real estate prices in India. One of the real estate indices that one can look at is the Reserve Bank of India (RBI)House Price Index. Look at Figure 3. It shows one- year returns in real estate per the RBI House Price Index, since June 2011.

                                                      Figure 3: Real estate returns (in %)Real estate returns (in %)

What is clear from Figure 3 is that the annual real estate returns have come down over the years. Now what happens when we plot Figure 2 and Figure 3 together. Look at Figure 4.

                                                                   Figure 4: Comparison Comparisonn

The Figure 4 shows that every time the real estate prices start to correct (i.e. the rate of growth in real estate prices starts to fall), lending from banks to real estate companies starts to pick up. Of course, the mapping isn’t exactly one to one. But there is a clear correlation.

There are two possible reasons for this. One is that banks do not want real estate prices to fall. This is because they feel that if real estate prices fall, the real estate companies won’t be able to repay their loans. Given this banks give fresh loans to real estate companies, so that they don’t have to cut their prices. This keeps the real estate bubble going.

The second possible reason is that the government (I don’t mean just the current government here but any government) does not want real estate prices to fall. This stems from the fact that the ill-gotten wealth of politicians is largely invested in real estate and they work towards protecting its value. Also, real estate builders are major financiers of political parties at local and state levels.

How is all this relevant in the current context? Real estate prices will start falling for sure. The trouble is that this is also likely to lead to default of bank loans from real estate companies. As of August 2016, the total lending carried out by banks to real estate companies stood at Rs 1,81,700 crore. If home loan borrowers also start to default, then there will be a bigger problem.

In this scenario, will banks come to the rescue of real estate companies again? Will public sector banks be forced to give fresh loans to real estate companies? On these questions, your guess is as good as mine. I don’t have clear cut answers to these questions. If banks do give fresh loans to real estate companies, as they have done in the past, then the real estate prices may not fall by as much as they are currently expected to. Nevertheless, it is safe to say, that whether real estate prices will crash, is actually in the hands of the Modi government.

Also, it is worth pointing out here that public sector banks are currently in a mess because of corporates defaulting on loans. Will they be able to take on real estate companies defaulting on their loans as well? What will the government do in this situation?

To conclude, I must say this that if the Modi government does allow real estate prices to come down dramatically, it will improve the affordability of homes. This will allow many people who cannot currently buy homes to buy homes. Also, lower prices will spur demand, which is currently more or less dead. Higher demand will lead to the creation of many low-skilled and unskilled jobs, which the country badly needs, with one million individuals entering the workforce every month. It will also lead to a multiplier effect in industries which directly depend on real estate for their demand.

All I can say with confidence right now is: Watch this space.

The column originally appeared in Vivek Kaul’s Diary on November 9, 2016.

The Luck of Investing in Real Estate


When flying out of the terminal 2 at the Chatrapati Shivaji International Airport in Mumbai, I like to follow a certain routine.

This includes eating a sandwich along with a cup of coffee and watching airplanes take off and land. The entire routine lasts for around 15 minutes. And this is precisely what I was doing two days back, when I saw a person walking towards me. I wouldn’t call him a long-lost friend but he was someone I had come to know during my course of work.

Don’t we all know a bunch of people we know, but we really don’t know? So, he was one of those.

“And who have we run into,” he said, sitting down in front of me. After the mandatory hello, this gentleman got to the issue straight away. “So why are you so against investing in real estate?” he asked.

“Well, I am not against anything. I am only against things which don’t make sense to me at a certain point of time. And as of now it doesn’t make sense to invest in real estate, in my humble opinion. But if you want to buy a home to live-in, that is a different issue altogether,” I explained, extremely irritated at having been disturbed.

“Oh, you know but the value of the home I bought has gone up four times,” he said with great confidence.

This is the oldest argument made by those still confident about investing in real estate. It comes in two forms. One form was just cited above. The other form is to talk about a third person who seems to have made money by investing in real estate. This can include Sharma ji, Verma ji, Gupta ji, Mr Banerji or Mr Subramanian, one of whom lives down the road.

This argument deals in absolutes. “I bought for Rs. 10 lakh and I sold it for Rs. 50 lakh,” is how you go about selling this point. The trouble is that it doesn’t take into account any expenses incurred in between.

This includes the maintenance cost that needs to be paid to the society every month. Or the property tax that needs to be paid to the municipality every year. Or the cost of insuring the home. Or the interest on the home loan. Or the cost of buying an insurance on the home loan. On the positive side, it does not include any rent that comes in and any tax deductions that are made.

The point being that no one calculates the return on investment on investing in property. In fact, there is no such number going around. If you want to know the past returns of a stock or a mutual fund, it is very easy to find that. But if you want to know about the past returns on real estate, there are only absolute numbers going around.

There are only stories. And people like to believe in stories, not numbers.

“So when did you buy this home?” I asked the gentleman.

“Around 2005,” he replied.

“You were lucky,” I blurted out.

“What do you mean?” he asked.

I had made the proverbial mistake of attributing the success of a person to his luck. And given that I would have to explain what I meant.

“Well, if you had invested in real estate any time post 2009, there is a reasonably good chance that your investment would have ended up in a mess,” I explained.

“What do you mean?” he asked again.

“Many people who invested in real estate post 2009, still haven’t got the homes they had invested in. The builders have either run out of money or in some cases simply disappeared.”

“Oh,” he replied, rather nonchalantly.

“So, in many cases people who thought they are buying a home to live in, have had to continue paying the rent on the home that they live in, along with the EMIs.”

“Oh,” he said again.

“They are basically screwed.”

“But what are you trying to say?”

“Success in real estate investing like many other things in life is also a matter of timing. You think you have made money because you invested in 2005. Many others who invested in 2009 or after, are stuck. And unlike other forms of investing there is no exit route. Also, given that the amount involved in this case is large, there is no getting back from it,” I explained.

“Oh, but all that doesn’t apply to me,” he said rather confidently.

“Really? So, this home you bought and which has gone up four times in value, have you ever tried selling it?” I asked.


“And for how long have you been trying to sell it?”

“For the last six months.”

“And you still haven’t managed to find a buyer for it?”

“No. I think it is worth a certain price. But the stupid buyers haven’t been willing to pay.”


“My broker also thinks it is worth the price that I think it’s worth.”

“Oh, really. The price you and your broker have, is in your head. That is certainly not the market price, because if it was, your home would have been sold by now.”

“That is not the case,” he responded very aggressively.

“You are anchored on to a price and are not willing to sell for anything less than that price. But in the time to come, as your home continues to remain unsold, you will revise your expectations and be ready to sell at a lower price,” I said, gulped my cup of coffee, and started walking towards gate number 87 to catch my flight.

To conclude, if you are unable to sell a house that you had bought as an investment, that doesn’t make the buyer stupid.

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

How UPA govt subsidies helped generate black money and contributed to the real estate bubble

One of the points that I have made over and over again in the columns that I have written on black money is that theNarendra Modi government needs to concentrate on domestic black money as well.

Since coming to power in May last year, the Modi government has made a lot of noise and come up with legislation on trying to curb the black money leaving the shores of this country. Black money is essentially money which has been earned but on which tax has not been paid.

Nevertheless, it is important to realise that ultimately almost all the black money is domestic i.e. it is generated within the country when people earn money (through legal or illegal means) and do not pay any tax on it.

Given this, it is more important to concentrate on trying to bring down the total amount of black money being generated instead of trying to get back the black money that has already left India. One way to do this is to get more people under the income tax net. Efforts are being made on this front.

A PTI report points out that: “The income tax department has launched an ambitious drive to bring under its net 10 million new taxpayers, after the government recently asked the official to achieve the target within the current financial year.”

Region wise targets have been set. Pune leads the list with a target of more than 10 lakh new assesses. This is an interesting move and if it is successful this will lead to more people paying income tax and hence, the total amount of black money within the system will come down.

When the total amount of black money comes down, lesser black money will go into real estate. And this will help in ensuring that only those who really want homes to live in,will buy. This will help in controlling real estate prices.

Other than getting more people to pay income tax, the government also needs to concentrate on blocking leakages on the subsidy front. In 2004-2005, the total subsidies offered by the government stood at Rs 47,432 crore. By 2013-2014, this number had ballooned to Rs 2,54,632 crore. The total subsidies of the government had jumped by 5.4 times during the period. In comparison, the total expenditure of the government had jumped by only 3.15 times.

Only if the subsidies were reaching those for whom they were intended for, it would not have been a problem. In October 2009, Montek Singh Ahluwalia, the then deputy chairman of the Planning Commission had said: “a Plan panel study on PDS [public distribution system] found that only 16 paise out of a rupee was reaching the targeted poor.”

So where did the remaining 84 paise go? It was stolen in between. Obviously people who stole the subsidies would neither be declaring this money as income and nor be paying any income tax on it.

As Saurabh Mukherjea and Sumit Shekhar of Ambit write in a recent research titled Real Estate: The unwind and its side effects: “Subsidies under the UPA regime grew at a staggeringCAGR[compounded annual growth rate] of 19% per annum…A substantial portion of these subsidies(30-50%) was pilfered by the political class and used by them to fund investment in gold and real estate.”

In comparison to Ahluwalia’s estimate, Mukherjee and Shekhar are being extremely conservative. Nevertheless, the point being made is the same—that government subsidies are terribly leaky. The politicians who stole this money obviously did not declare this as income. This black money then found its way into real estate and drove up real estate prices.

As a FICCI report on black money published in February 2015 points out: “The Real Estate sector in India constitutes for about 11 % of the GDP of Indian Economy, as these transactions involve high transaction value. In the year 2012-13, Real Estate sector has been considered as the highest parking space for black money.”

So what has happened since the UPA was voted out of power? In 2015-2016, the total amount of subsidies have been budgeted at Rs2,43,811 crore, which is lower than the Rs 2,54,632 crore that had been spent in 2013-2014. One reason for this is obviously a fall in oil prices. The number in 2014-2015 had stood at Rs 2,66,692 crore.

This cut in subsidies along with the fact that some subsidies are now directly being paid into bank accounts is likely to help bring down both black money as well as real estate prices. As Mukherjea and Shekhar write: “The NDA has cut subsidies sharply (down 9% in 2015-2016) and is shifting subsidies to Direct Benefit Transfer (DBT); at least 10% of the overall subsidies have already been moved to the DBT. As a result, the ability ofthe politician-and-builder to pilfer subsidies to fund real estate construction has been checked.”

While cutting down on subsidies further may not be politically possible, if more and more of subsidies are paid directly into the bank account of the beneficiaries, the total amount of black money within the system is likely to come down.

Taking these steps rather than chasing black money that has left the shores of this country makes more sense and will have a greater impact on bringing down real estate prices in India. This will go a long way in making homes affordable for those who want to buy homes to live in rather than to invest.

As Mukherjea and Shekhar put it: “the NDA Government is engineering a clamp down on black money in India. The 2015-2016 Union Budget explicitly aimed to disincentivise the black economy and curb the demand for physical assets. With the new Black Money Bill (which was passed by the Parliament on May 26) and with the Cabinet approving the Benami Transactions Bill in May this year, the crackdown on blackmoney will continue further.”

These steps need to continue.

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

The column originally appeared on Firstpost on July 20, 2015


And what will happen to the Chinese real estate bubble?

chinaAt the heart of the financial crisis which started in September 2008 was the real estate bubble in the United States and large parts of Europe. The impact of these multiple bubbles bursting is still being felt in the Western economies, more than six and a half years later.
The impact of these bubbles bursting was felt in other parts of the world as well, including China and India. China has managed to limit the damage of these real estate bubbles bursting by creating a real estate bubble of its own, over the last six and a half years.
China has gone on a huge borrowing binge in the aftermath of the financial crisis. The country has borrowed close to $20.8 trillion between 2007 and mid 2014. This is more than one-third of the money that has been borrowed globally during the period. To give readers a sense of how massive this borrowing is, the Chinese have borrowed more than 11 times India’s most recent gross domestic product of $1.87 trillion.
The McKinsey Global Institute recently released a very interesting report titled 
Debt and (not much) deleveraging. This report points out: “From 2000 to 2007, total debt grew only slightly faster than GDP, reaching 158 percent of GDP, a level in line with that of other developing economies. Since then, debt has risen rapidly.” By mid 2014, China’s total debt had touched 282% of its gross domestic product (GDP). This is greater than the debt to GDP ratio of some of the most developed countries in the world like Australia, the United States, Germany, and Canada.
The biggest driver of this growth in debt was borrowing by non-financial companies, primarily property developers. “At 125 percent of GDP, China now has one of the highest levels of corporate debt in the world,” the McKinsey report points out.
Nearly 45% of the borrowing or around $9 trillion is related to real estate in one way or another. Between 2008 and August 2014, property prices in China rose by 60% as per an index of 40 Chinese cities. Prices rose by 76% in Shenzen and by 86% in Shanghai. In fact, residential property prices at the premier locations in Shanghai are only around 10% lower than similar properties in cities like New York and Paris.
“Property prices have increased as well, as households have bought homes and invested in real estate to find better returns than bank deposits offer,” the McKinsey report points out. Nevertheless, property prices in China have been falling over the last one year.
As often happens in such cases when “easy money” is available the Chinese developers ended up building more homes than there was a demand for and are now finding it difficult to service their debt. In fact, on Monday (April 20, 2015) Kaisa, one of the largest integrated property developers in China, defaulted on interest that it had to pay on its debt.
In a statement to the Hong Kong Stock Exchange the company said that it had not made interest payments on its bonds due to mature in 2017 and 2018.
Business Insider points out that the company “didn’t pay $16.1 million in interest on its 2017 notes, or $35.5 million in interest on its 2018 notes.” Experts who follow the real estate sector in China closely feel that other large Chinese real estate sector companies will also default in the time to come.
Given this, it is not surprising that the activity in the real estate sector is slowing down. As Wei Yao of Societe Generale points out in a recent research note: “The contraction in property starts deepened further, from -17.7% year on year in Jan-Feb to -19.5% year on year in March, making the past quarter (-18.4% yoy) the second worst in history. Land sales, in volume terms, revealed a similar deterioration and were one-third less compared to a year ago in March.”
The Chinese government understands that a major portion of Chinese growth in the aftermath of the financial crisis has come in from the real estate sector. Given this, it has started to step in to ensure that the real estate sector continues to drive growth. “The combination of the policy-easing measures announced in late March, mortgage rules relaxation and bigger tax break, should support a housing sales recovery in the coming months,” writes Yao.
Over and above this, the People’s Bank of China on Sunday (April 19, 2015) cut its reserve ratio by 100 basis points at one go. One basis point is one hundredth of a percentage and reserve ratio is the portion of deposits that banks need to maintain with the central bank. This massive cut will add nearly 1.3 trillion yuan into the Chinese financial system, giving an incentive to banks to cut interest rates particularly to real estate companies as well as on home loans.
The problem is that the Chinese banks are not in a mood to pass on the lower interest rates to borrowers.
As a recent Reuters newsreport points out: “Beijing has tried to revive a flagging housing market as it looks to arrest an economic slowdown, but banks are increasingly worried about bad debts and are not passing on policy steps like interest rate cuts and lower downpayment requirements to home buyers…But the banks’ stance means policy is not feeding through to the real economy. And as the housing market accounts for about 15 percent of China’s economy, it is crucial to stopping the loss of economic momentum.”
To that extent the situation is a tad similar to that in India, where the Reserve Bank of India (RBI) has cut interest rates twice since the beginning of this year, but the banks are in no mood to pass on that cut, given that they are sitting on a huge amount of bad loans.
Getting back to China, one thing that makes the Chinese government different from that of India is that it has much greater control over the economy than the Indian government has. It has recognized this slowdown in the real estate sector and at the National People’s Congress(NPC) in March 2015 (a good time to remember that in China, the party and the government are one and the same) revised the GDP growth target to 7%. As Yao of Societe Generale wrote in a research note released in March 2015: “The Government Work Report, released at the opening session of the NPC meeting, carried few surprises. A number of economic targets have been set lower than last year (see table 1). The much hyped growth target is now “around” 7%, but the urban job creation target was unchanged at “more than” 10m, compared with the actual result of a 13m increase in 2014.”
And if the situation becomes worse than it currently is where more Chinese real estate companies start to default on their debt, the government is in a position to rescue the financial sector, like it has done before. As the McKinsey report points out: “China’s government has the capacity—if it chooses to use it—to bail out the financial sector even if default rates were to reach crisis levels. This would most likely prevent a full-blown financial crisis. Because China’s capital account has not been fully liberalized, spillovers to the global economy would most likely be indirect, via a further slowdown in China’s GDP growth, not through financial contagion.”

The column originally appeared on The Daily Reckoning on Apr 23, 2015