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Raghuvir Srinivasan

THE decision to liberalise norms of foreign direct investment in the construction sector is perhaps one of the more important economic policy decisions taken by this Government in the nine months of its existence. The Government has permitted 100 per cent foreign direct investment in the construction sector with the liberty to repatriate profits after a three-year period.

The minimum project size for foreign investors has also been reduced from the present norms, based on feedback from prospective investors. These decisions open up immense possibilities, not just for the real estate and construction sectors, but also for the economy as a whole.

The construction industry is a major driver of economic growth in any country. Examples abound of economies that were built purely on the construction boom. Singapore and Hong Kong are two that come to mind immediately.

The construction sector accounts for upwards of 6 per cent of GDP (gross domestic product) in any advanced economy.

For example, it accounts for about 8 per cent of the UK's GDP, 16 per cent of Ireland's and 11 per cent of Dubai's. The construction sector was one of the prime drivers of the impressive 16 per cent growth in Dubai's GDP in 2004.

In India, the construction sector accounts for about 6 per cent of GDP, which is not bad but certainly not good enough, considering that it is a developing economy where huge investment should be going into construction activity. Though the construction sector includes industrial construction, roads, ports and other infrastructure, it is in real estate that the new liberalised rules will have the maximum impact.

Development of the real estate sector has not been uniform across the country. While cities such as Mumbai, Delhi, Gurgaon and Bangalore have been a realtor's paradise, others such as Chennai, Hyderabad, Kolkata and Pune have lagged. However, these cities are now fast catching up, especially Chennai and Pune, as land becomes scarce in Mumbai and prices go through the roof in cities such as Bangalore.

One of the major impediments to organised growth in the real estate sector has been the absence of big players with deep pockets and the capacity to assume big risks. Save for exceptions such as DLF in the Delhi-Gurgaon belt and Hiranandani in Mumbai, the sector is largely made up of small-to-medium sized players who have neither the resources nor the capacity to assume the risks that come with large projects.

The result has been disorderly development with a proliferation of small projects that help neither the promoter nor the buyer. In short, the industry is far from maturity.

That could now change as foreign investors with large financial resources at their command invest in the country.

For instance, even an investment of $100 million, which is small by global standards and should be easily affordable to a medium-sized realty company abroad, will be remarkable in India, translating as it does to Rs 450 crore.

For instance, Singapore's Lee Kim Tah Holdings, a well-known property developer, is implementing a township project on the outskirts of Chennai in association with an Indian company and its equity investment is just $5 million — approximately Rs 25 crore. Now, even this is a large investment by Chennai's standards and has dwarfed other residential projects in the city. More than the residential, it is the commercial segment that will be benefit from the liberalised norms.

Typically, the returns are higher in commercial than in residential projects and foreign investors would prefer implementing large commercial projects as it is easier to sell to institutional customers than a large set of disaggregated individual buyers.

The entry of foreign investors may also lead to the development of an organised real estate finance market. In the developed countries, real estate mutual funds, or REITs (real estate investment trusts) as they are called, are as popular as stock market mutual funds.

REITs are unknown in India because the real estate industry is not organised and there are few large institutions in the construction business.

Besides, the industry also has a murky reputation, with allegations of underworld money financing projects, especially in Mumbai. A vibrant construction industry can also benefit the larger economy due to the ripple effect.

From producers of cement and steel to banks and financial institutions, the list of industries that will benefit is long. Just one move — increased tax deduction on housing loans — has set off a boom in the residential real estate segment in the last couple of years.

The liberalisation of FDI norms now may well set off a second boom in the real estate industry.

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