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Commentary

FinMin Pressures RBI to Prolong Housing Bubble?

In response to buyers not being able to afford property and thus not allowing builders to buy more Bentleys*, the Finance Ministry has asked RBI to consider making housing a part of the "infra" sector, which will help to increase price even more.

The finance ministry has asked the Reserve Bank to consider giving infrastructure status to the housing sector, and relax provisioning norms for it so banks can extend attractive loans to buyers.

RBI has mandated that banks set aside from their profits an amount equal to 1% of total standard assets in commercial real estate, which also includes housing projects. This means if a bank lends 100 towards a commercial real estate project, it will have to keep aside 1 to offset any loan to the sector turning bad. The provisioning rises to 15% of net investment in case of secured sub-standard asset.

A finance ministry official confirmed the government has asked RBI to look at all possible options to provide an impetus to the housing sector.

Here’s why I hate this concept. Real estate is not "infrastructure". If it was, then we would be giving infra status to the auto industry, the furniture industry, the TV industry and even the toothpaste industry. Housing is not infrastructure. Infrastructure is something on top of which other things can be run – roads are, since it provides access and thus businesses can be built around it. Ports are because they facilitate transfer of goods and passengers over the sea. An Airport is. (An individual airplane is not). A house is not, and therefore the housing sector is not.

Secondly, we have just seen massive housing bubbles burst in the west due to horrible policy actions of promoting housing over all other things. (We do too) Japan’s real estate market hasn’t recovered in twenty years, and neither has its economy. Don’t tell me India is different. It is not. It’s the same crap peddled with an Indian accent.

The impetus is simply because RBI has provided better lending and provisioning norms for infrastructure projects. Infra projects are an NPA only if they are delayed by over 2 years, while a delay of 6 months will cause them to be NPAs if they are not an infrastructure project. This will help banks that have provided loans to builders, whose projects are now seriously delayed, since the recognition of an NPA means that banks have to provision 15.00% (initially), up seriously from the current 0.25% to 1.00%.

Further, the infra sector enjoys relaxed ECB (external commercial borrowing) norms, lower initial provisioning, and some special clauses in takeout financing. But should we be giving an even higher status to real estate? The answer is no. Becuse they already have a high enough status.

In "Building affordable housing by curbing bubbles in real estate", I wrote about how we have mollycoddled this sector, pretty much at the cost of most other retail funding.

We allow large tax cuts for housing

I mean seriously large, compared to anything else, really.

1. You, as an individual taxpayer, get a deduction of Rs. 150,000 per year on interest paid, deducted from your income. If you think this is okay, consider that you don’t get to deduct on interest in any other expense (with the possible exception of educational loans). You can’t get a deduction in the interest paid for a car loan, a personal loan or even on the loan to pay the medical expenses of your family. Housing gets an elevated status.

2. You get to deduct even the principal (upto Rs. 100,000) in a combined format under section 80C.

3. Further, for a second house, you can deduct the FULL interest (without limit) from your salary or other income. In other business ventures you can deduct interest against income made from that venture, not against your salary or capital gains income. For housing, a second house’s interest cost can be deducted even from your salary income! What are we telling people? Don’t bother investing in a business, invest in real estate instead? That’s just encouraging a bubble.

4. Capital gains when selling houses can be avoided by just buying another house. You can’t do that with any other capital asset. Profit from gold? You can route that into a house and get a capital gains tax waiver; but you can’t do it the other way around. This

Home lending is further prioritized

RBI allows banks to allocate their capital based on what they lend to. So if they lend you money for a personal loan, they have to provision some money against it, and further, they have to put a "risk weight" on it. For housing loans below 25 lakhs, the weights are lower; in effect, giving housing loans a priority over others, and this results in lower lending rates.

Lending to real estate companies is now often disguised as loans to retail buyers, though back-to-back arrangements like "Builder pays your EMI" and "Upfront Loan" kinds of products. The idea here is that the builder gets the money you borrow, at a lower rate, and it doesn’t even get qualified as loans to them (which distorts the data on sector concentration for banks).

In this context, with so many incentives, is it sane to now classify the sector as an "infrastructure" sector? I say no, and I say let’s start penalizing it now. Because of this attitude:

Home sales across the country have dropped over the past year because of unrealistically high prices. The finance ministry has been trying to impress upon developers to reduce prices to improve sales. It has also advised banks to fund partially finished housing projects that are viable, if developers are willing to bring down prices.

But developers say bringing down prices would be difficult unless liquidity for projects improves and interest rates for housing projects are reduced.

Really? Prices will only move up if rates are reduced, sir. That’s the way of every market.

Can we not go down the same path that seems to have cannibalized western economies?

* I am kidding. I’m sure they have better use of the money than buying Bentleys. Like buying a helicopter.

  • Nagarajan says:

    I hope there is a huge bubble in housing. I can effort something after it bursts 🙂
    Every country is trying to print money out their trouble, why not India also do it. May be the government should announce a one time housing loan waiver like farm loan waiver. Sure recipe for success in the upcoming elections. and a sure recipe for inflation/rupee decline.
    on a serious note, how do we protect our savings from this mad governance Gold/Hard Assets/Stocks… ?

  • Ramanand says:

    Before housing is accorded infrastructure status (if at all), some things related to housing need to be cleaned up as well. Primarily:
    1. Repeal of the ULCA (urban land ceiling act) allowing for development of large rental housing complexes owned and managed by individual/institutional owners for the explicit purpose of profit.
    2. Repeal of the Bombay rent control act.
    3. No tax deduction to individuals for interest on housing loans (an argument which Deepak has already made vis-a-vis auto loans/personal loans)
    4. No tax deductions on repayment of principal of housing loan (also covered)
    5. Property taxes to be set based on facilities provided to a property by the local authorities which are indexed to inflation (and not to property values!)
    6. Elimination of VAT or other such taxes that are of ‘one time’ nature that affect only the first buyer but not subsequent buyers of a resale property
    7. Rationalize stamp duty and registration charges (You don’t pay 7.5% of the purchase price during Equity share purchase do you? Then why target property purchases)
    8. Allow depreciation of house price as a tax deduction from income. Tax capital gains accordingly (same as depreciation to industry)
    I could probably go on…but you get the idea…:-)

  • mangoman says:

    Hi Deepak,
    Excellent write up. Finance minister is crossing all limits to save these realty sharks. We cannot change the laws of economics how hard you do. Japan tried it and paying the price for 20+ years. US tried and failed. Atleast they are recover.
    Do you think if the slump comes in India can we recover without a civil war or sorts?
    I honestly feel there should be 2-3% interest rate hike by RBI to clear all excesses..what do you think? Do you think historically this 8%repo rate is high? When I joined bank in 1998 I remember we paid 11-12% rate for depositors. Why we cannot pay the rate now?
    mangoman2012.blogspot.in

  • I am getting old waiting for real-estate crash to happen 🙂 I am close to giving up the hope now.
    I do believe real-estate story in India is somewhat different than other developed countries due to:
    1. Amount of illegal (corruption, drugs etc.) money stashed in real-estate: This money can tolerate any amount of negative yield.
    2. Amount of black money (tax cheating, cash transactions) stashed in real-estate: This money can afford fairly large negative yield on investment.
    3. All kinds of idiotic government regulations pointed out in this article.
    4. Amount of land ownership with politicos. They have interest in making sure prices don’t go down and they create laws.
    This ridiculously fast growing bubble is making all business which require any amount of space un-viable but who cares…

  • Prajwal says:

    Deepak,
    Aside from cash for buying/building/repairs, shouldn’t we [the govt] look into
    – Empty sites
    – Empty and locked apartments
    Also what if there are no legal heirs? Shouldn’t the property get recycled and sold off ?

  • Phoenix says:

    Excellent write up. CREDAI has now asked the govt for more concessions!!!
    Helicopter is an understatement. These crooks are all billionaires.
    Deceit, fraud and lies. There are more spicy details which I will not comment on. That is how babu’s give clearances!

  • Krish says:

    The sops to the Housing sector meant to benefit individual customers, opposite is happening. The sops are used by the builder to raise the prices. The private foreign banks are charging exorbitant interest rates. In this nexus, builders and banks are the net beneficiaries. No wonder they are lobbying hard to infuence the government to 1. reduce the rates by RBI 2. considering the special status for RE 3. Restructuring of builder loans
    With many high ticket corporate loans gone wrong in recent times, all banks are convinced that ‘housing’ is the only sector capable of absorbing the bank liquidity and they too joined the bandwagon along side of the builders.
    In the next budget, I won’t be surprised if the home interest limit is raised for tax exemption and RBI announcement of lowering the interest rates ( it is other matter whether the reduced rates are ever passed on to the customers).

  • Dhirubhai says:

    I partially agree to your viewpoint that the government is giving mis-incentives and will do more harm than good in their aim to lower property prices.
    At the same time, dont you think that capital markets in this country are also being given a big incentive. No Long terms capital gains tax since the last decade (almost) !!!
    Very few countries have let this revenue source go waste =(except a few island countries or places that are globally established financial centres.

    • There are tiny little incentives for everything; including buying tax free bonds. Certain incentives are okay, but housing gets way too many. Keeping long term cap gains tax free is, in my opinion, not sustainable at all and I think we should remove it; it forces people to go to public markets instead of other investment avenues. I would argue the same with other 80C investments. I think only those investments should be allowed that really build a retirement kitty (like a pension plan), without an upper limit, and any early withdrawals should be taxable.