The Hindu Business Line : How India has steered clear so far

The sub-prime crisis that strangled the US economy is leaving nagging questions in the minds of Indian investors and FIIs: will the contagion stifle the Indian stock market? Subsequently, every time a bank or a financial institution in the West caught a cold the Indian markets sneezed. And, taking a cue from the US stock market, alarmists pummelled the Indian stock indices to record one-day lows.

This, despite the market being poised to ride on good corporate results for three quarters in a row this year. No doubt, the unmitigated appetite for frontline stocks by FIIs has been stretching valuations beyond reasonable levels.

There are reasons for a nuanced market correction from these bloated valuations. However, is a similar correction on the anvil as a fallout of the sub-prime crisis? Facts and figures released by the Reserve Bank of India last week should dispel such worries.

Scorching pace

Virtually doubling every year, the real estate sector grew at a scorching pace in the gross non-food credit. From Rs 13,546 crore in fiscal 2005, real estate credit grew by 97 per cent to Rs 26,693 crore in 2006 before levelling to 70 per cent at Rs 45,328 crore in 2007.

One of the prime reasons why the ebullient growth was tempered would have been the Finance Ministry directly talking down credit to the sector, which was promptly followed by policy initiatives. And yet the overall growth remains startling.

While a cursory glance at this rapid growth and gross numbers should ring alarm bells in the corridors of power, at 2.5 per cent of gross non-food credit, the overall macroeconomic picture is still not daunting. However, timely intervention by the Government to stave off a potential crisis should be welcomed.

It was an unprecedented demand for housing and commercial space during the last decade that triggered the real estate boom. The decade-old surge in demand for housing and commercial space stems from recent spurts of accelerated economic development.

This transferred increased wealth and purchasing power into the hands of India’s booming middle-class — fuelling an unbridled demand for goods and services, which in turn triggered the unprecedented demand for housing and commercial space. The Government further stoked this demand by encouraging liberalised and easy credit norms, nurturing a fall in interest rates and offering lucrative tax breaks. The demand for housing has never really looked back since then.

Yet, there have been stark differences in the volume of bank credit to the real estate sector vis-À-vis the magnitude of housing loans extended to the borrower. The extension of credit to the housing sector was almost five times the credit extended to the real estate sector in 2007.

Two years earlier, in 2005, the difference was almost ten-fold. Extension of housing credit grew from Rs 1,33,908 crore in 2005 to Rs 1,85,181 crore in 2006 and settled down to Rs 2,30,689 crore in 2007.

The slump in growth rate of housing loans, from 38 per cent in 2006 to 24 per cent in 2007, is an indicator that the surge in interest rates has forced several customers to defer housing investment plans. But it is just a matter of time before they re-enter the market.

Major Anomaly

This brings out a major anomaly: while the requirement of funds from the demand side – housing loans – have been most lavishly provided for, the requirements from the supply side – development of real estate – have been virtually starved. Could this have created the present real estate price bubble? Not necessarily.

The price bubble is still confined to a few cities and there too, often in isolated pockets of affluence. Left to the market forces, economic development has a tendency to concentrate in such pockets, leading to far higher real income enjoyed by the people of the locality.

This leads to a heightened demand for goods and services and a spiralling location-specific demand for housing and commercial space. Since neither land nor real estate is infinite commodity, the prices sometimes bubble out of control. It is, therefore, not surprising that the price for commercial space and housing in the heart of Mumbai is among the highest across the major cities of the world. But, thankfully, the contagion has not spread as rapidly across the rest of the county. And yet, this should still be no cause for consolation.

Catalysts for boom/bust

Experience from the developed world show that demand-supply economics and paucity of funds by themselves may not be the long-term accelerator or brakes in real estate markets. Instead, it is often the direct outcome of economic development. Demand-supply and availability of funds act as facilitators and catalysts for the process.

These catalysts can either hasten or slow down the natural dynamics in the real estate market.

As the economic development process intensifies, cities and towns grow and mushroom and often real estate price bubbles become an inevitable consequence. Despite the seeming inevitability of the process, the government should intervene and prevent such bubbles.

In the US, the real estate bubble spread from prime locations of major cities as banks vied with one another offering credit at high rates (sub- prime rates) to cover increasingly risky real estate investments.

The investors found quick and easy returns as real estate prices went up, justifying the risky investments.

The cycle began to collapse as the pace of economic development began to cool and rates of interest remained strong.

Real estate prices began to wilt even as rates remained high, and the first casualty was the investor. As their numbers began to proliferate, its impact began to manifest on the bottom-lines of banks as well.

Signs of bubble

In a similar fashion, bubbles have begun to form in certain pockets in India. But they are unlikely to take alarming proportions as yet, since the base of credit to real estate is quite low and that for the housing sector is still manageable. Moreover, credit extension to both the sectors has contracted during last year on account of high interest rates and government intervention.

Also, there are no prime and sub-prime rates based differential risk perception in India. Finally, real estate prices in India seems more real since they continue to be backed by accelerated economic development and better purchasing power.

For a sector which has locked in huge potential value in land, the funds and investments coming into the sector are still small. And, looked at from the overall macroeconomic perspective, the numbers are not yet threatening. The inherent value of land gets unlocked only as economic development accelerates. In a stagnant or slow-growing economy, real estate prices are more likely to be ephemeral bubbles.

And yet, vigil should remain the catch-word. There have been reports of bank funds being diverted and deployed into the booming real estate sector.

Also, huge funds are on tap from the capital market. As long as Indian institutions are left unscathed, the possibilities of a sub-prime crisis overtaking the economy remain remote. However, if huge and disproportionate funds are mobilised and deployed into real estate, several people could eventually burn their fingers.

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