Real Estate Intelligence Service, Friday, July 03, 2009

Government of India: Economic Survey 2008-2009

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Economic Survey 2008-2009

State of the Economy
Challenges, Policy Response and Medium-Term Prospects
Fiscal Developments and Public Finance
Prices and Monetary Management
Financial Intermediation and Markets
External Sector
Agriculture and Food Management
Industry
Energy, Infrastructure and Communications
Human Development, Poverty and Public Programmes
Statistical Tables
Economic Survey (All Chapters) [English] [Hindi]
Economic Survey (All Tables) [English] [Hindi]

Economy is sound, let's push reforms, says Economic Survey

Economy is sound, let's push reforms, says Economic Survey
Business Standard, July 3, 2009, Page 1

BS Reporter / New Delhi

Painting a picture of a resilient economy, the pre-Budget Economic Survey 2008-09, tabled in Parliament today by Finance Minister Pranab Mukherjee, said India could grow up to 7.75 per cent in 2009-10, up from 6.7 per cent in 2008-09, provided the global economy, particularly the United States, bottomed out by September and the government was able to push the button on significant economic policy reforms.

The World Bank had recently said India would grow 8.1 per cent in 2010, ahead of China (7.5 per cent). The numbers in the survey also suggest India is finally ready to rub shoulders with its northern neighbour.

The economy, according to the survey, can count among its strengths the large services sector which has historically been less affected by cyclical downturns than manufacturing, a strong farm sector, robust savings rate, ambitious infrastructure development programme and upbeat foreign investors. The "shock absorbers of the economy," it said, were the sound banking system, large foreign exchange reserves, a comfortable external debt position and low inflation. It listed as concerns the dip in growth of private consumption and gross capital formation and said the downside risks were the reduced availability of risk capital, lower capital inflows and delayed revival of the OECD economies.

In keeping with the resurgent mood, the survey listed an ambitious reform agenda for the government, a clear signal that it was no longer weighed down by the Communist parties. Surcharges, cesses and new taxes like commodity transaction tax, securities transaction tax, fringe benefit tax and dividend distribution tax had reversed the move towards a simpler tax system, it said. The first three of these taxes were introduced by Mukherjee’s predecessor, P Chidambaram (2004-08). High government-administered interest rates on small savings, it added, had kept lending rates from coming down.

Reflecting the new-found boldness of the Manmohan Singh government, the survey made some radical suggestions like restricting the cooking gas subsidy to six or eight cylinders for a family every year, auction of freely tradable 3G spectrum for next-generation mobile telephone services, raising foreign investment in defence to 49 per cent, opening up multi-brand retail, restricting price control to drugs with just five or six players, relaxing the contract labour laws and permitting retrenchment of workers by companies without prior permission.

It conceded that the return to the path of fiscal correction could occur next year with a fiscal deficit target of three per cent of GDP by 2010-11, mobilisation of at least Rs 25,000 crore through disinvestment, de-control of petrol and diesel prices as well as sugar and fertiliser industries, opening coal mining for the private sector and reform of pension, insurance and retail sectors.

"These reforms should be implemented over the next four to five years, which will take the country back on trend of growth," said Arvind Virmani, chief economic advisor in the ministry of finance. These, however, are just a wish list of the finance ministry and may not be implemented in full by the government.

To balance the interests of farmers and consumers, the survey suggested that there should be a domestic price band for agricultural commodities within which imports and exports are freely allowed. If the international price threatens to exceed the brand, export restrictions and lower import duties would kick in and vice-versa. To rein in the fuel subsidy, it suggested temporarily taxing upstream crude oil producers. (This demand was made last year by the Samajwadi Party at the height of the crude oil crisis.)

The survey suggested that the indirect taxes, that were reduced in the recent part as part of fiscal stimulus package, could be restored once the economy is back on track. “The approach of the government has been to use a mix of fiscal measures including reduction in indirect which could be reversed subsequently,” it said.

In the last financial year, 2008-09, the government had cut peak excise duty rate in two tranches from 14 to 8 per cent and service tax from 12 to 10 per cent.

In spite of the optimistic projections, the survey raised doubts about the global economy, especially the “green shoots” of recent commodity price rises. According to the survey, this could be “a result of position-taking by financial investors, seeking to benefit from global recovery expectations due to the large fiscal and monetary stimulus and/or to hedge against inflation risk in the United States due to the massive quantitative easing.”

WHAT NORTH BLOCK WANTS Some key policy prescriptions

For fiscal stability, simplicity

* Limit LPG subsidy to 6 to 8 cylinders a year per household
* Limit kerosene subsidy by ensuring that every rural household has a solar cooker and lantern
* Convert fertiliser subsidy to user nutrient-related subsidy
* Revitalise disinvestment programme to raise at least Rs 25,000 crore a year
* Rationalise dividend distribution tax
* Phase out surcharges, cesses and transaction taxes such as securities transaction tax, fringe benefit tax
* Auction 3G spectrum and allow it to be freely traded

For financial markets

* All financial market regulation under Sebi
* Allow high net worth individuals to invest directly in the markets
* Set up centralised debt management office
* Align voting rights in banks with equity holdings
* Phased increase in FDI in banks

For energy efficiency

* Decontrol petrol and diesel prices
* De-nationalise coal to allow private entry
* Sell oil fields to private sector

For business

* Raise FDI limit in insurance, defence, allow it n multi-format retailing
* Allow private entry into the provision of passenger train/railway services
* Remove need for prior government permission to retrench workers but raise compensation requirements
* Ease contract labour laws Amend Factories Act to increase workweek to 60 hours from 48 hours

The first statement of intent from new govt

The first statement of intent from new govt
The Financial Express, July 3, 2009, Page 4

Indranil Pan

The annual report card for the economy indicated definite strains to the economy as a result of the global economic crisis. However, it also points out the rosier side. The hope that the Economic Survey raises is that the inherent strengths of India are many and these can ultimately help mitigate the adverse impact of the global downturn. Though the deepest period of the crisis indicated demand as the constraining factor for the Indian industry, the services sector was relatively healthy. Also, the scaling up of rural development programs including the NREGS has enabled the rural consumption demand to stay on the stronger side. Added to this is the fiscal stimulus, mainly in terms of the 6th Pay Commission awards and the lower interest rates by RBI that buffered any fall in consumption demand.

This Economic Survey could be read as the first statement of intent of the new government, the direction to the management of the economy that can be expected from the short-term perspective of the Union Budget announcement on July 6 and also the long-term challenges to restore back the high growth path for the Indian economy over the next 5 year period. Unlike the fire-fighting skill of the last government, the skills of the present government would lie in the management of the economy so as to ensure the sustainability of the “green shoots” in India and maintain investor confidence.

In this sense, the tight rope walk would be to manage the stimulus process in the short term and time the removal of accommodation of monetary and fiscal stimuli suitably so as to ensure a process of medium-term consolidation. The Economic Survey lays out these challenges clearly when it indicates that the Budget Deficit should return to around 3% of GDP at the earliest, roll back interest rate cuts as the economy revives and also drain out the excess cash to curb inflation.

The Survey lays out the reform orientation needed to ensure that the economy returns to a high growth path. Though difficult to implement all in the immediate Budget exercise, the intent seems clear. The plan is to revitalise the disinvestment process to net Rs 25,000 crore each year. Further the government is expected to set-up a road map to reform the subsidies segment to reduce leakages and ensure proper targeting. And lastly, the goal would be to converge various schemes with a thrust on quality of expenditures and outcomes. The Economic Survey also indicates the need to broaden the long-term debt market by liberalising the investment norms of insurance and pension funds, development of credit enhancement institutions and also tax incentives for long-term debt market. The introduction of repos and derivatives in corporate debt is under consideration. This will go a long way to ease the funding problems for India Inc, especially for infrastructure development.

The writer is chief economist, Kotak Mahindra Bank.

SURVEY MOOTS SWEEPING REFORMS, BUT THAT MAY JUST BE A DREAM

SURVEY MOOTS SWEEPING REFORMS, BUT THAT MAY JUST BE A DREAM
The Economic Times, July 3, 2009, Page 1

Swaminathan S Anklesaria Aiyar NEW DELHI

THE Economic Survey predicts GDP growth as high as 7.75% in 2009-10 if the global economy turns up by autumn, and a reasonable 6.25% if the global recession drags on. Exuding confidence on the external front, the survey predicts a current account surplus of up to 2.8% of GDP, and estimates that the inflow of FDI into India in 2008 was $46.5 billion.

The document suggests that disinvestment of public sector undertakings can raise at least Rs 25,000 crore per year for the government. The details of the asset-sale plan will be announced by finance minister Pranab Mukherjee when he presents the Budget for the year to March 31, 2010, on July 6, finance secretary Ashok Chawla told reporters.

The survey also suggests the re-introduction of tax on dividends (in place of the corporate dividend tax). If implemented, millionaires who today pay no tax on dividends will pay it henceforth at the highest rate.

The document claims that high savings and investment rates, rural prosperity, and resilient service exports have kept the economy going despite horrendous global conditions. It focuses less on the need for fresh economic stimuli than on post-recession strategy to reverse fiscal and monetary easing, and stresses the need to return to FRBM targets, possibly by 2010-11.

Replete with dozens of suggestions for economic reforms, the survey is clearly a Montek-Virmani document rather than a Sonia-Pranab Mukherjee one. It represents the reformism of technocrats rather than the realpolitik of politicians. Once upon a time, the Economic survey used to be viewed as a declaration of intent of the government. This time it is better viewed as a declaration of despair by technocrats, listing reforms that are urgently needed but have no hope of political acceptance.

On the fiscal side, the proposed reforms include a cyclically-adjusted zero deficit target; limiting LPG consumption to 6-8 cylinders/year per family; replacing subsidised kerosene with solar lanterns and cookers; decontrolling petrol, diesel prices and fertiliser and sugar industries; freeing fertiliser prices and instead giving fertiliser subsidies directly to farmers; auctioning 3G spectrum; eliminating tax exemptions and moving towards a uniform duty structure that eliminates inverted duties; lifting the ban on agricultural futures; liberalising spot and future currency markets; auctioning rights to external commercial borrowings; phasing of FDI limits in banks and aligning voting rights with shareholding; allowing private sector entry into coal mining and nuclear power; creating a competitive electricity market by liberalising open access; raising FDI limits to 49% in insurance, and to 100% for companies providing every type of insurance; raising the FDI limit to 49% in defence industries; implementing police, judicial and administrative reforms; and amending labour laws to permit up to 12 hours work per day, including overtime.

That is a reforms agenda that, if taken seriously by the government, would send the Sensex soaring to 20,000.

Worst may be over, survey sees signs of revival, expects a recovery in second half


THE BOOSTERS

Rs 25,000 crore Target suggested by the survey for PSU disinvestment every year

Fiscal stimulus to the economy to continue

Credit markets functioning normally, no dearth of liquidity and benign inflation


High investment rate in recent years has boosted the productive capacity of the economy

Rs 28,000cr From auction of 3G spectrum if the govt accepts the survey suggestions

Robust rural economy to continue to drive growth

THE DAMPENERS

75% DEPENDENCE on imported crude. The survey sees any sharp increase in international crude prices as a major risk to the economy

SLOWDOWN in growth rate of capital formation; a possible current account surplus in 2009-10 means India will be a net exporter of capital

SHARP DIP in growth rate of private consumption

BUDGET WISH LIST

Return to FRBM targets for fiscal deficit at the earliest

Simplify direct tax regime with possible phaseout of surcharge, cesses and transactions taxes— STT, FBT & commodities transaction tax

Abolish dividend distribution tax (DDT), tax dividends in the hands of receiver

Rationalise Customs duties, move to a uniform duty to correct inverted structure

A road map for disinvestments with yearly targets

Reform fertiliser, petroleum and food subsidy regime

Road map for deregulation of oil sector

Sops such as cheaper credit for export sector

Plan for future FDI regime

Tax sops for purchase of commercial vehicles

Open up coal sector as it remains a bottleneck for accelerated development of power sector

Cos Bill to be re-introduced

Cos Bill to be re-introduced
Business Standard, July 3, 2009, Page 1

The Cabinet approved the re-introduction of the Companies Bill in the current Budget session of Parliament. The Bill was passed in the Lok Sabha last ear but lapsed with the change of government.

PSBs trim exposure to commercial realty

PSBs trim exposure to commercial realty
The Hindu Business Line, July 3, 2009, Page 6

Rising loan defaults turn banks cautious.

Prudential step: Despite being flooded with loan requests, banks have reduced exposure to new commercial realty projects because of increasing stress on assets.

C. Shivkumar

Bangalore, July 2 Faced with mounting delinquency in the commercial real estate sector, public sector banks have pruned exposures to commercial realty to 10 per cent of capital funds.

Top PSB officials said that the measures were taken in view of the asset stress in the sector. Exposure limits till last year ranged between 15 and 20 per cent of the net-owned funds. Most accretions to the PSBs’ delinquent asset portfolios in the last financial year were from the commercial realty sector, officials said.

Although the Reserve Bank of India does not indicate sector-specific exposure ceiling on commercial real estate, the guidelines provide flexibility to individual banks to fix limits. PSBs, the officials said, have taken advantage of this guideline, as a prudential measure.

However, banks are still being flooded with loan requests for commercial realty projects. The Vijaya Bank Chairman and Managing Director, Mr Albert Tauro, said, “Yes, there are several loan applications from commercial realty projects. We are still examining them.”

Asset stress

But bank officials said that in many portfolios, asset stress was already evident, with falling loan-to-value (LTV) ratios. In many cases, the LTV ratio has dropped below the prudential level of 1.5 times. 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, the LTV ratio tends to rise. A falling LTV, however, implies depreciation in the value of the asset. This has begun happening, officials said.

Under international practices, banks normally tend to ask the borrowers to maintain increased margins in the event of a sharp depreciation in the value of the underlying assets. In the current situation, though the LTV ratio has dipped to about 1.1 times, there is little scope of increaseing the margins, in view of the high levels of loan delinquencies , they said. Consequently, banks were left with little alternative but to treat the assets as non-performing. A loan is treated as a substandard asset if the debt servicing is overdue for more than 90 days.

This was despite the fact that PSBs, unlike private sector banks, apply the LTV ratio on the basis of the actual project cost instead of the market value of the asset. Private banks used the latter during the heyday of aggressive asset chasing, between 2004 and 2006. But despite the tight lending practices, the officials said, in many metros, the LTV ratio was down for commercial realty projects, implying depreciation in asset values and few takers for such assets. They said that the trend was particularly pronounced in Delhi, Mumbai, Kolkata, Chennai, Hyderabad and Bangalore where the main focus was on commercial realty projects.

Debt rescheduling

Bank officials said that some project promoters had also begun approaching banks for corporate debt restructuring. The CDR mechanism allows the promoters a reprieve from being classified as non-performing assets. The terms of the loans are restructured and payments rescheduled. The mounting recourse to CDR also turned out to be a signal for PSBs to choke credit to new commercial realty projects.

Get realty off green radar, set up regulator

Get realty off green radar, set up regulator
The Times of India, July 3, 2009, Page 22

Team TOI

Controversial regulatory reforms in the environment sector found their way into the Economic Survey too. The report recommended that housing and real estate sector be taken out of the purview of the central environmental clearances regime. It also recommended the creation of an autonomous environmental regulatory authority, which environment and forests minister Jairam Ramesh had made part of his agenda.

Ramesh had earlier said the ministry was considering the creation of an environment protection agency that would subsume the role of the Central Pollution Control Board as well as the ministry’s regulatory sections. The Survey also recommended that degraded forestlands be handed over to the paper industry. The controversial proposal has cropped up several times in the past couple of decades and each time put on the backburner with stiff opposition from several quarters.

In the UPA’s previous tenure too, the idea was floated with the environment ministry proposing leasing government forests to the industry in a PPP model. But the proposal was put off though not completely abandoned. The paper industry has again reached out to the government pushing the idea.

On other environmental concerns, the Survey suggested replacing the use of kerosene in rural India with solar lanterns and cookers in order to reduce the subsidy bill. At the same time, it asked for the creation of a national waste mission. The mission would create a multi-level national sewerage grid and a national solid waste collection and disposal system to run parallel to the attempt to clean water sources.

On depleting water sources, the Survey has given life to the proposal to price water in rural India while providing free or low cost water entitlements to the poor through smart cards, vouchers or bank accounts. The move seconds the suggestion of the Planning Commission which was made in its report in 2008.

WORST IS OVER but complete recovery eludes

WORST IS OVER but complete recovery eludes
The Economic Times, July 3, 2009, Page 11

SURVEY CALLS FOR EASING CURBS ON FDI, DECONTROLLING SUGAR AND FERTILISER INDUSTRIES, LIMITING PRICE CONTROL TO ESSENTIAL DRUGS & CREATING INTERNET-ENABLED DATA SYSTEM

THE government may ease curbs on foreign direct investment (FDI) and introduce an array of reforms to reverse a decline in industrial growth witnessed in the last two fiscals. An indication to this effect was given in the Economic Survey, presented to Parliament on Thursday. However, the Survey said there were a number of positives such as a revival in power generation, an improvement in cement dispatches and higher credit offtake indicating that the worst may be over for the Indian industry.

The reforms could include allowing FDI in multi-format retail, starting with food retailing, raising FDI limit in defence industries to 49%, decontrolling sugar and fertiliser industry, limiting drug price control to essential drugs and creating an internet-enabled data system to help small and micro businesses, the survey said. It also suggested a review of labour laws to encourage economic activity.

One of the main reasons for the poor performance of the industrial sector over the past year was high raw material prices. In July 2008, Indian crude oil basked was priced at $132 per barrel. The persistent rise of crude prices impacted petro-based industrial inputs adding to fuel cost. An increase in the prices of other commodities, particularly metals and ores, from the latter half of 2006-07 to the second half of 2008-09 also hurt the manufacturing sector. In fact, cost on account of consumption of raw materials rose by as much as 38% and 44% during the first two quarters of 2008-09, compared with 16% and 12% in the first two quarters of the previous fiscal.

A sharp increase in interest costs, especially from the third quarter of 2007-08, also added to the woes of the sector. The country is pinning its hopes of an industrial revival on a fall in raw materials prices. The decline in crude prices, low raw material cost and declining interest rates should help the industry to improve profit margins, which have been under pressure, the survey said. Lead indicators and other related information collected by various research analysts also point to an upward movement in terms of demand and supply, it added.

A sustained inflow of FDI points to foreign investor confidence in the Indian economy. The survey said India, on account of its market size, output generation and prices, would continue to be an attractive destination for foreign investment at a time when most industrial economies are struggling on industrial front.

The survey said that a decline in the number of strikes and lockouts indicated an improvement in industrial relations in the country. During 2008, Tamil Nadu experienced the maximum instances of strikes and lockouts followed by Kerala, Andhra Pradesh and Karnataka. Industrial unrest was concentrated mainly in financial intermediation, textiles, transport, mining of coal and food products. The survey said it was imperative to facilitate the growth of labourintensive industries, especially by reviewing labour laws and labour market regulations. The government, however, has always been cautious about proposing changes in labour regulations as labour is a sensitive issue and all state governments need to be brought board.

DLF raises Rs 1,000 cr through land sales

DLF raises Rs 1,000 cr through land sales
The Economic Times, July 3, 2009, Page 18

Sanjeev Choudhary NEW DELHI

DLF has raised around Rs 1,000 crore through sale of land parcels across four cities in the past 4-5 weeks and is on course to close more such deals worth another Rs 500 crore in the coming weeks, two company executives said.

This is in keeping with the country’s largest real estate developer’s announced objective of raising Rs 5,500 crore through asset sale and use these funds to halve its Rs 14,000 crore debt by the end of this fiscal.

DLF has sold off land parcels in Mumbai, Baroda, Gangtok and NCR. The plots in Prabhadevi, Mumbai and Baroda were not marked for any specific purpose, as the company hadn’t paid government fees and obtained licences for any specific use. DLF has sold a hotel project in Delhi and another in Gangtok.

Chennai-based investor C Sivasankaran bought DLF’s 66% rights in the Prabhadevi plot for Rs 310 crore, while another Delhi-based high net worth individual bought a hotel project in Delhi. The details of other transactions were not available.

A slump in Indian property market has forced several developers to sell assets to improve cash flow. A dramatic decline in sales of homes, offices and shops coupled with tight credit situation between September and March forced many realty firms to put their assets on sale as they found it difficult to repay debt and continue with the execution of their ongoing projects. DLF’s smaller rival Unitech sold off its hotel in Gurgaon and an office building in Saket in the past few months. But selling assets, especially land hasn’t been easy for any developer as there were hardly any buyer for land. DLF though has successfully closed multiple transactions of late.

The DLF spokesman declined to comment, but two senior executives at the firm confirmed the raising of Rs 1,000 crore through asset sale in the last. They also said that DLF has finalised a buyer for its land parcel in Andheri, Mumbai, and is close to signing the deal. Similarly, the company is in final stages of negotiations with private equity fund Duet group to sell its hotel plot in Gurgaon for Rs 110 crore.

The company has put on the block hotel plots at many other locations including Lucknow, Kasauli, Goa, Mumbai and NCR, which the company expects to fetch at least Rs 500 crore together.

DLF, which is in a deleveraging mode, plan to use the newly-raised fund to repay debt. Much of what has been raised so far and what is likely to come in the future through asset sale will go towards reducing debt. DLF vicechairman Rajiv Singh had earlier said that the company intended to halve its Rs 14,000 crore debt by March 2010.

HDIL raises Rs 1,688 cr

HDIL raises Rs 1,688 cr
The Financial Express, Corporates & Markets, July 3, 2009, Page 1

Realty developer Housing Development & Infrastructure Ltd (HDIL) has said it will raise Rs 1,688.40 crore through the issue of shares to qualified institutional buyers (QIBs) on a private placement basis. The company’s QIP has resolved to issue up to 7.03 crore equity shares at Rs. 240 a piece, aggregating to Rs 1,688.40 crore, HDIL said in a filling to the Bombay Stock Exhange. The issue of QIP, which opened on June 29, closed on Thursday, it said. Further, the committee has also approved to issue 26 crore covertible warrants at a price of Rs 240 per piece to the promoter of the company on a preferntial basis. Shares of HDIL were trading at Rs. 235.20 down 0.55% in the late afternoon trade on the BSE.

Emaar to try IPO route again

Emaar to try IPO route again
The Economic Times, July 3, 2009, Page 18

In Talks With Kotak Mahindra Capital To Handle IPO Worth Over Rs 4,000 Crore

Abhishek Gupta & Mohit Bhalla ET NOW

EMAAR MGF has taken the first step towards return to the stock markets by opening talks with an investment banker, apparently enthused by the success of its peers in raising cash by privately placing shares to institutional investors, two persons with knowledge of the development said.

ET NOW has learnt that the property developer has started preliminary discussions to appoint Kotak Mahindra Capital to handle its initial public offering (IPO), 18 months after its first attempt failed.

Emaar MGF, a joint venture between MGF Developments and Emaar Properties of Dubai, could be looking to raise at least Rs 4,000 crore although it is not clear how much stake the company will dilute.

An investment banker close to the development said that Emaar MGF executive vice-chairman Shravan Gupta recently met a senior Kotak Mahindra official, to discuss the fund-raising plan. Kotak Mahindra Capital is the investment banking arm of Kotak Mahindra Bank.

“Emaar MGF continues to evaluate various funding options to meet its growth plans. However, we are not in a position to comment on the specifics of any of our fund-raising plans,” a company representative told ET NOW.

A person familiar with the company’s plans said that Emaar MGF’s move has been encouraged by the recent investor interest in real estate companies. DLF, Indiabulls Real Estate, HDIL and Sobha Developers have in recent weeks raised over Rs 8,000 crore through Qualified Institutional Placements of shares.

Their success has also emboldened Shriram Properties, part of the Chennai-headquartered Shriram Group, to appoint Macquarie and Enam Financial Consultants as advisors for a proposed Rs 500-700-crore initial public offering.

The successful IPO last month of Mahindra Holidays, which raised Rs 300 crore, is also being seen as a sign of a revival in the primary market for equities.

The failure of Emaar MGF’s share offering—billed as India’s third-largest after Reliance Power and DLF—in February 2008 marked the beginning of a deep freeze in the IPO market. The property developer was looking to raise Rs 6,400 crore by selling a 10% stake but pulled out after cutting its price twice when only 39% of the issue was subscribed.

The company since then has been on the lookout for funds and was recently bailed out by the Delhi Development Authority, which bought 333 apartments for Rs 700 crore in the 2010 Commonwealth Games Village it is developing. Emaar MGF also got a commitment of receiving $150 million from Emaar Properties last year.

Shobhana Subramanian: Jerry Rao's nano-housing dreams

Shobhana Subramanian: Jerry Rao's nano-housing dreams
Business Standard, July 3, 2009, Page 13

Rao's model treats land as inventory and not as an asset

Shobhana Subramanian / Mumbai

It’s wonderful that Jerry Rao is planning to build houses that cost Rs 700,000 or less. The former Citibanker’s model is simple enough: land is bought with the equity capital while construction is financed through bank loans at market-related rates currently anywhere between 11 and 13 per cent. The key to the success of the project is the time taken to complete it. If the houses are ready in 12-18 months as planned, Rao expects he can generate a return on equity (ROE) of close to 30 per cent. The ROE, of course, keeps falling as the time to completion increases and after 36 months, drops to single digits.

The big difference between this model and that followed by most developers today is that land is treated as inventory and not as an asset. Typically builders try to buy land cheap and hoard it till the price appreciates after which they extract a higher price from home buyers. The short point is that most developers today are trying to make money from the land rather than the project. Since they believe land prices will appreciate, they are in no hurry to complete their projects—they divert money received from customers for one project to some other venture and there’s no accountability, whatsoever, when it comes to completing projects on time. Of course, they stand to profit enormously from the price appreciation—operating profit margins for leading developers have been upwards of 60 per cent before the downturn began. And if the debt blows up in their faces, there is always the government to bail them out! It’s time developers were asked to house each project in an SPV, as will be the case with Rao’s venture, so that the money can be kept track of.

For sure, there are a couple of risks to Rao’s model. The first is that given the relatively low selling price, restricted to between Rs 1,300 and Rs 2,000 a sq ft, the projects necessarily need to be located not just on the outskirts of cities but perhaps way beyond that. Boisar, where Tata Housing’s project is coming up for instance, is located 100 km from Mumbai. The question is whether people will be able to commute from these distances, how much time they will spend travelling and how much it will cost them. If people can’t get to the place of their work within a reasonable amount of time, they would rather live in a chawl. The response to Tata Housing’s Boisar project , however, suggests there’s huge pent-up demand at this price point. Whether people are planning to live in Boisar or only move there when they retire, remains to be seen.

The other question is whether the prospective buyers will be eligible for home loans. Buyers will somehow manage to put together the down payment and may well be in a position to pay back the loan. But will banks be willing to take on the credit risk and bear the relatively higher cost of customer acquisition of these small-ticket loans? If they’re not willing then the effective demand for this kind of housing could be far lower—just in tens of millions maybe, rather than in hundreds of millions.

The biggest risk though is execution because state governments, with their bureaucracy and red tape, can hurt developers badly. Real estate is known to be a dirty business but it will be really unfortunate if projects like Rao’s are hurt by inefficient and corrupt officials.

That will keep other developers away given that these are already low-margin projects. Already bigger developers weren’t even willing to construct apartments for middle-income groups till the downturn forced them to do a rethink. Many now claim to be doing ‘affordable’ housing, though the prices don’t suggest that; all they’re doing is building smaller houses and selling them at slightly lower than the peak rates.

In a recent report, CRISIL has defined affordable to mean a price that 60 per cent of the population in a particular area can pay. It’s found that in the top six cities, this price is below Rs18 lakh, in tier II cities like Pune and Ahmedabad, it’s below Rs 16 lakh, while in places like Ujjain or Aurangabad, it’s below Rs 9 lakh. It’s clear from this that most people can’t dream of owning homes within city limits given land prices. Since the government is doing precious little to help out, it should at lease ensure that projects like Rao’s take off.