Indian economy: will the stimuli work?

The global financial market meltdown and its effect on the Indian economy has forced the Reserve Bank of India and the government to initiate some more measures for uplifting the sagging economy. Let us examine the details of the ‘stimuli” and its possible effect on the housing sector.

The main accent of the RBI’s stimuli is on interest rates. The government’s package is a mixed bag — additional budgetary expenditure of Rs. 20,000 crore, tax/duty cuts and increased lending by public sector banks.

The major policy announcements by the Reserve Bank made on December 6 are:

Reduction in repo rate to 6.5 per cent and reverse repo to 5 per cent

Housing loans up to Rs. 20 lakh to be treated as ‘priority sector’ lending

Refinance of Rs. 4,000 crore ( details to be announced after the meeting of RBI Board, slated for the current week), for the National Housing Bank for financing construction/purchase of dwelling houses under the priority sector to individuals/families

Five per cent ceiling on housing sector priority quota within the overall priority sector lending; such loans sanctioned up to March 31, 2010

Concessional treatment to commercial real estate lending and consumer loans extended up to 30-6-2009.
Interest reduction war?

Even before we read the news item in the morning papers, the television channels beamed the decision of ICICI Bank to reduce interest on home loans to 11.5 per cent from 13 per cent, a hefty reduction of 1.5, on housing loans up to Rs. 20 lakh. While the general public may be carried away by this high speed action, since the ongoing interest rate movements are a by-product of the ‘stimuli’ to the sagging fortunes of the Indian economy as a result of the global meltdown, other steps are necessary as a follow-up measure.

The government came out with a package of economic revival ‘stimuli’ on December 7, which has certain direct and indirect measures to support the real estate sector, such as

Housing loans up to Rs. 5 lakh to be treated on special footing.

Loans above Rs. 5 lakh and up to Rs. 20 lakh to be treated as priority at concessional rate.

CENVAT relief of four per cent for all dutiable items.

Special approach to residential housing segment.

Why the reduction in rate only to loans up to Rs. 20 lakh?

The specific plan behind the RBI’s declaration of housing loans up to Rs. 20 lakh as ‘priority’ sector is not very clear. However, this only prompted the ICICI to pass on the repo rate reduction to lower and middle class investors who are shying away from investing due to high prices.

Interest on home loans during the last two years.

The home loan rates climbed from around nine per cent to about 14 per cent during the last couple of years. This, along with the increasing cost of construction materials, service charges, cost of stamp duty and registration charges, enhanced the cost of investment in the housing sector by 20-25 per cent. Coupled with the general rise in land cost, this increase has discouraged investors, especially the lower and middle class. Promoters and builders who had big plans for expansion have deferred their plans to invest in new ventures. As a result, the housing market has been dull and demand has came down by almost 25 to 30 per cent, according to top builders.
Cheap money policy

The urgency shown by the RBI and the open direction from the former Finance Minister last month will certainly encourage banks to pass on the reduction in their cost of funds to the borrowers in general and to the small investors in real estate. However, not extending the reduced rate to all the existing borrowers may have negative effect. Most of these loanees may opt to change over to other banks. Another possible effect can be the borrowers utilising the opportunity to limit their borrowing to the upper limit of Rs. 20 lakh in order to get the benefit of lower interest. Yet, the idea needs to be welcomed.

Major effects on the sector can be:

Fillip to long term lending, say 25-30 years.

Preference to floating rates.

Relocation from congested cities to less crowded towns.

Movement from central districts to outskirts.

Green structures to counter climate changes.

Development of townships in and around metro rail terminals.
Cautious approach

Another point to be debated is whether all banks will be in a position to reduce interest on lending unless their cost and asset liability match. Despite positives, it is better to wait and watch for a while. In case the recession is to continue for a while, say 2-3 years, the money value can come down substantially. Optimism pays, but caution can be the watchword. If interest rates go down continuously, the benefits should be fully availed by the borrowers, as the up-cycle will come, may be a tad late in the day! The good news, however, is the positive responses from many banks such as BOB, BOI and Oriental to reduce the rates.

Compensation for mental agony too

In a recent case, the A.P. State Consumer Redressal Commission increased the compensation amount to offset at least a reasonable portion of loss incurred by a customer.

M. Srinivasa Raju, a resident of Saroornagar, purchased a plot from Sreemitra Real Estates Pvt. Ltd. in August 2002. He made the initial payment of Rs.49,625, but however, stopped the further payments as the developer refused to allocate him the plot. His repeated requests were ignored.

Mr. Raju filed a case against the developer in Ranga Reddy District Consumer Forum seeking repayment of his money together with Rs.50,000 towards interest, Rs. 1 lakh as compensation and Rs.50,000 for mental agony.

The District Forum ordered the builder to refund the paid money Rs.49,625 along with interest of 9 per cent per annum from July 2004 till the date of realization and compensation of Rs.2,000 and Rs.500 for court costs.
Better compensation

Upset with the amount of recompense, Mr. Srinivasa Raju challenged the verdict in the State Commission. He argued that if he was refunded the money when he had asked, he could have purchased another plot in city and would have earned a good market value for it.

He further said he would get only a meagre compensation with the interest rate granted by District Forum and pleaded for better compensation.

The State Commission found force in the contention of the customer.

It observed that if customer was refunded his money in 2003 itself, he could have bought another plot and benefited from the increased land rates.

The State Commission modified the order of the District Forum keeping and asked the builder to repay Rs.49,625 with interest rate of 15 per cent per annum from August 2004 to the date of realisation.

It increased the compensation and legal expenditure amounts from Rs.2,000 and Rs.500 to Rs.25,000 and Rs.1,000 respectively.
Cases cited

The Commission cited three cases - Lucknow Development Authority v. M.K. Gupta, Haryana Development Authority v. Suman Bansal, and Haryana Development Authority vs. S. P.Gupta, which were tried by the Supreme Court.

In the verdicts of these cases, the apex court stated that consumer fora should specify the amount under each head while awarding the compensation and due compensation should be awarded for mental agony and harassment. The time given for compliance was one month.

Too many tongs in the fire

Now that the government’s integrated townships on a Public Private Partnership mode’s draft policy has come into the public domain, initial excitement seems to be giving way to trepidation. Stakeholders concerned like real estate developers, technocrats and experienced officials have been raising quite a few pertinent points on the issue.

Few are ready to buy the argument that the current slump is the right time to get “budget projects” grounded, the basic premise on which the new policy envisages. As much as 40 per cent of the purported township’s plotted area is to be earmarked for economically weaker sections, low income and middle income groups.

People in the business wonder if it’s practical to go for such housing when 10 per cent of the township is reserved for open spaces and another 10 per cent of residential area is to be handed over free to the sanctioning authority for its own usage? “Can any entrepreneur be successful by taking such a project? Is the government washing off its responsibility to provide housing for poor,” asks an official, incredulously.
Business lobby pressure

He points out that an earlier plan to earmark 20 per cent land in each layout for such a purpose in Hyderabad Metropolitan Development Area (HMDA) came tumbling down to five per cent following incessant pressure from the builders-politicians lobby. “And, even there are no proper modalities on how the reserved space is to be utilised, the cost factor, selling price and probable beneficiaries,” he says.

A previous attempt to sell such houses did not serve the purpose as even the “low price” was way above the affordable range of the target group.

Putting onus on private parties to develop townships is fraught with risks as the contentious land acquisition could lead to more legal wrangles as incentives are simply not enough, argue few others.

“The market value rates upon which cash compensation is to be paid will not be acceptable since it denotes to official values which is too low,” points out a developer. There was also a danger of such townships becoming inaccessible from rest of the urban area.
Gujarat example

Instead, the government should follow the Gujarat example where the urban development authority takes over all the land delineated for a township, builds basic infrastructure like internal and arterial roads, earmarks public spaces, etc. Most importantly, it allows a plot owner to retain his ownership allowing him or her to sell when the time is ripe.

Also, asking developers to build and also maintain civic amenities in such townships is expecting too much, say critics. “When governmental agencies have failed to provide for proper civic infrastructure anywhere, is it possible for private players to do the job? What is the guarantee the developer will do it, if at all or qualitatively, after the plot or apartment is purchased? There are many cases of such failed promises,” says an official.

While giving a push to real estate is imperative, government should seriously consider giving it an industry status as there will be easy finances and tax benefits along with some much needed regulation to protect the consumers’ interests, feel some.
No Master Plan

Without a proper Master Plan in place, it is foolish to go ahead with such projects as it would do against the very tenets of the policy of organised growth, is an overwhelming opinion among stakeholders. Hyderabad itself had a Master Plan in 1975 and a new one is yet to see light of the day even as it has been a stupendous growth.

The prices…..in the wake of terrorism

Most of us consider the interest rate as the key factor affecting real estate prices. While a combination of factors can affect the demand and consequently prices, terrorism can be the most lethal market buster.

Commenting on the terrorist attack on Hotel Taj, Trident-Oberoi and Nariman House, the Singapore Prime Minister expressed the view that investment in India can be adversely affected by the developments. The then Finance Minister, P.Chidambaram, admitted that the Mumbai siege may mar the mood of the investors and could have negative impact on investor sentiments at least in the short run, but the Indian economy has the strength to overcome it fast. The rating agency, Standard and Poor, however, does not expect any negative impact on India’s macro economy. The terror strikes, they say, are isolated incidents. Percy Mistry, economist and head of an expert committee on making Mumbai an international financial centre, which recently submitted a road map for the same, is reported to have stated that the terrorist attack can erode investor confidence. What is the factual position relating to property prices?
Risk perception

Investment in real estate mainly depends on the risk perception. Risks are from many angles. First and foremost is the safety of one’s investments and the return for it. Next, the class of investor/s who contribute a good percentage of the investments in property. In the case of Indian real estate, individuals form only 10-15 per cent of the transactions, especially from the volume point of view. Surveys have shown that the institutional investors form around 40-45 per cent of the value of deals done in the last 3-5 years. Banks, finance companies and software firms own office premises in major cities as they plan for medium to long-term benefits. If this is true, risk perception will be high in the short term. Yet, the global financial meltdown does not give many alternatives for funds and trusts to get reasonable returns for their investments in liquid assets and they have to turn to the property market. Some may even use the slump to buy property in risky metros.

If terror attacks are dampeners, the 9/11 World Trade Centre attack in New York did not affect property prices in New York city. Even in the Philippines, the killings of tourists did not stop further property development. Nearer home, the 2001 terror attack on Parliament in Delhi did not have any adverse effect of property prices in the metropolis. The risk perception is a wholesome feeling and again comparative in nature. In fact, terrorism is now a global phenomenon and there is no place which can be considered insulated against it. This means among the risk Factors such as fire, flood, earthquake, and now terror all have pivotal role in risk perception.

In this background, Indian property prices cannot be considered high as compared to the ‘street specific’ top few cases as reported recently. For example, the most expensive sq.ft. prices at Rs 8.45 lakh on Avenue Princes Street in Monaco, Rs. 5.40 lakh in Seven Road, Hong Kong, Rs 3.60 lakh in Fifth Avenue, New York, etc are not comparable to any area in Mumbai or Delhi or Kolkata . At best, the price of Rs. 52,000 reportedly paid by a foreign bank in Mumbai last year for securing an office space could well be the highest in India. In such a situation, a reported slump of 10-15 per cent seen in Mumbai market overnight cannot be considered alarming.

Much needs to be done to protect properties from terror risk. Some important steps can be:

Insurance against risk of terror attacks.

Business Districts must spread its wings to interior locations.

International property exchanges covering property stocks, so that risk can be neutralised by investing in stocks of different countries.

Cities including Hyderabad, Bangalore and Chennai have lower property price rates as compared to Mumbai or Delhi. In such a situation, it is likely that investors may turn to these cities for taking the advantage of lower prices. This may perhaps help the sagging market too to look up. Let us wait and watch.

Consumer can no longer be taken for a ride

In a recent verdict, the A.P. State Consumer Disputes Redressal Commission (APSCDRC) censured Narne Estates Pvt. Ltd. for its unethical business practices.

The State commission commented that the company was harassing and causing loss to the consumer and its efforts to repudiate the agreement were unethical.

T. Vijaya Kumari, a resident of Indian Airlines Employees Colony, purchased a plot from the company in its East City extension in January 1998. She paid Rs.40,000 by the end of 2000 as per the initial agreement. She was asked to further pay an amount of Rs.43,750 towards development charges.

Accordingly she paid the charges by February, 2003. The company refused to register the plot on her name and it offered an alternative plot, which was not acceptable to the buyer.

Hence, the buyer asked for repayment of her amount. However, she could get only Rs.81,250 out of Rs.83,750.

She was told that Rs.2,500 was deducted towards outstanding dues, which never existed.

The company neither paid interest on the money for keeping it for three years nor compensation for going back on its promise.

The annoyed buyer filed a case at Hyderabad District Forum-III seeking for Rs.3,75,000, the then market rate of the plot, with 24 per cent interest rate per annum, Rs.2,500, which was deducted illegally and Rs.50,000 towards compensation besides court costs of Rs.10,000. The company didn’t oppose the case at the Forum.
Deficiency in service

All in all, the District Forum stated that not registering the plot after taking the entire sale consideration, amounts to deficiency in service.

However, the forum awarded only a compensation of Rs.50,000 besides costs of Rs.2,000. The company contended the verdict in the State Commission. It said that the compensation of Rs.50,000 was on the higher side and it argued that it was not liable to pay either interest or compensation since it proposed to register an alternative plot.

The commission pointed out, that the reasons put forth by the company for not registering the plot were inconsistent. It further stated that compensation of Rs.50,000 cannot be termed high, as the company locked up the consumer’s money for three years by which she has lost her plot at a time when land prices in the city escalated.

However, Ms. Vijaya Kumari was not granted the market rate as she couldn’t submit any proof to support her argument.

Home loans: rise in slippages worry banks

Banks have begun stress testing their realty assets as delinquencies in loan service payments begin mounting.

Bankers said that many banks were facing overdues on some of the past realty loans and some home loans. The slippages noticed were mostly through an increase in overdue debt service payments for up to one month. In the past, overdue payments were very low.

Bankers said that in at least 10 per cent of the home loan accounts, they had experienced such slippages.

Two years ago, when rates were low, the slippage was minimal. Only about 2 per cent of the home loan accounts experienced such slippages, the bankers said.

Such slips in debt service payments notwithstanding, banks see little need to classify the accounts as sub-standard assets.

Vijaya Bank’s Chairman and Managing Director, Mr Albert Tauro admitted “There is an increase in debt service payment slippages. But this is not an immediate cause of worry.” This was because despite the overdue payments, they were yet to reach the threshold level of 90 days. Assets are classified as non-performing only if the debt service payments were overdue for more than 90 days. Besides, for most banks, realty and home loans comprised less than five per cent of their gross assets.
Unfinished projects

Bankers said some realty projects had been left unfinished for want of buyers, increasing the risk of loan delinquencies.

As a result, most of them were limiting loans to the realty sector to contain risks and assessing potential risks through stress testing of the assets.

Stress testing implied assessing the potential for asset delinquency. Asset delinquencies were on the rise in several public sector banks.
Rising NPAs

Bankers are resorting to moral persuasion, persuading borrowers to settle their overdue payments.

However, despite such efforts, NPA accounts have been on the rise. In the second quarter of the current financial year, the average NPAs of the banking sector is already close to 1.5 per cent of advances.

For the last financial year, the average was about 1.3 per cent of advances.

Banks’ worries are not just confined to rising NPAs in the realty sector. In many cases, the loan-to-value (LTV) ratio has dropped below the prudential level of 1.5. Under current guidelines, banks are expected to maintain physical asset coverage of at least 1.5 times (150 per cent) the loan value.

Normally as loans are amortised, LTV ratios tend to rise. A falling LTV, however, implied depreciation in the value of assets.
Distress sales

Mr Lakshmi Narayanan, president and Chief Executive Officer, The Real Estate Bank of India, said “Distress sales have increased. Some developers are resorting to discounted sales for meeting liquidity requirements.”
Balance sheet losses

Realty prices consequently are sliding. LTV ratios are currently down to 1.22 with the drop in the value of realty prices in most metros.

Bankers said that if realty values dropped further, LTV ratios were also likely to drop further. This meant that in the event of loan foreclosures, banks would have loan losses on their respective balance sheets.