How to get rid of corruption in real estate?

In this issue:
» RBI issues tighter norms for six big banks
» GMO chief rips of Fed chair over her rate policy
» Marc Faber: Market is in bubble; stocks to fall by 30%!
» Rs 1 trillion needed to end India's power woes
» ...and more!

00:00

The real estate sector is muddled with corruption and black money menace. The prevalence of latter has not only inflated housing prices but also ensured that owning a property remains out of a common man's reach.

Since real estate is the avenue where unaccounted cash can be parked easily, as most transactions happen off record, it attracts huge amounts of black money. In fact, as per reports, during 2005-2010 FDI in India's real estate has jumped 80 times! It is widely believed that this money was routed through shell companies that are located in tax havens abroad. Basically, this is nothing but round tripping which makes tracing the source of black money difficult. Of course, such a huge influx would cause property prices to rise as well.

So, the question is how does one get rid of corruption and black money so that property prices eventually reach sanity?

For that we reckon cash transactions on properties should be disallowed. In order to save on taxes and stamp duties people generally indulge in cash transactions. Say for example, if the property is worth Rs 10 m. In most cases, its official registered value will be much lower. Let's assume Rs 5 m in this case. The balance amount generally gets paid in cash. This way the end user saves on stamp duty and capital gains taxes, if any.

However, people forget that in such transactions they effectively don't save anything but are at a bigger loss. In the desire to save taxes they prefer to pay cash. But this is effectively unaccounted cash (Rs 5 m in our example) which continues to circulate in the real estate funnel.

As there is no other avenue which can easily absorb black money with so much ease, more people park their money in this asset class via the unaccounted mode. This inflates property prices. And it is ultimately the end user who bears the brunt. He may save on taxes by paying in cash. But forgets that the end price he pays to buy the property is much higher, thereby offsetting any benefit from saved taxes.

So, will a vow to not pay in cash by the end user eliminate corruption & black money peril? Obviously not, if you ask us, but it will certainly reduce the hazard to some extent. The reason being one also needs government's active participation to help fight this social evil.

Increasing floor space index (FSI) or land supply by changing the land classification guidelines can reduce property prices. If prices decline and come to more realistic levels unaccounted money would steer clear of real estate in search of better returns elsewhere.

Lastly, as an article in First Post suggests, government should enforce guidelines which monitor capital flows moving into real estate from overseas markets. For instance, China has such a guideline in place to ensure that excess liquidity from abroad does not create a bubble in its property market. This becomes especially important in the Indian context as FDI in India has jumped 80 times in this sector during 2005-2010, as stated earlier.

However, the question is whether the government will oblige and make such radical changes. Well, considering the builder-politician nexus it is anybody's guess. Unless political stakes in real estate subside property prices won't, is what we reckon.

Do you think eliminating cash transactions will result in property prices coming down? Let us know in the Equitymaster Club or share your comments below.

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01:50		Chart of the day

China and India are two of the fastest growing economies in the world. As far as the former is concerned, manufacturing supremacy aided by low cost capital and subsidized exports have been some of the prime reasons for the growth. However, China is witnessing certain changes that could impact its status as an export hub. Consider this. The Chinese Yuan has gained 33.3% against the US dollar in last 10 years as can be seen in today's chart. What this implies is that the exports from China will not be as cheap as they used to be. Especially in light of the fact that over the same period, other economies like South Africa, Indonesia and India have seen depreciation in their currencies.

And this is just one of the many reasons why China may get hit as far as exports supremacy is concerned. Unlike in the past, the labour cost in China has gone up. Meanwhile, the labour supply has become tight. Further, with China getting serious about clamping shadow banking, its manufacturing sector that is a major driver for exports is unlikely to get the support as in the past. A withdrawal of export subsidies by China in various sectors is a further dampener for China's exports. However, what is going to be China's loss could be a huge gain for India. Around 23.5% depreciation in rupee against dollar in last 10 years makes Indian exports quite competitive. What could aid India further are the favorable demographics, cheaper wages, access to raw materials and spare manufacturing capacities. As such, India seems to have the right mix of elements to dominate the exports market. All it needs to march ahead are the right policies and an uptick in global demand.

Will rise in Yuan derail China's export hub status?

*SA= South Africa

02:25

Will she, won't she? Raise rates that is. While the US Fed has begun trimming its bond purchases, interest rates were kept close to zero. And now it appears that Janet Yellen is not keen on raising interest rates going forward. In other words, she prefers continuing with the Fed's easy money policy. Jeremy Grantham, founder of money manager GMO, thinks this is a big mistake. He opines that very low rates will certainly encourage extreme speculation. And we agree. We have time and again pointed out, that the Fed's loose monetary policies have hardly done much in terms of bolstering economic growth. All it has done is raise asset prices as a result of which there is a big disconnect between the stock markets and the economy. Because of too much money chasing assets, concerns have begun emerging of bubbles being formed here. The irony is that this appears quite similar to the scenario prevailing before the 2008 financial crisis. Indeed, years of cheap money had finally reached a point where it culminated into the global financial crisis. And the tools that the Fed is using to solve the crisis are what caused it in the first place. This means that as long as these policies continue, we will not be surprised if there is another bigger crisis lurking in the corner.

02:45

Just yesterday we wrote about how investors continue to salivate at the prospect of banks in India getting bigger. Especially big enough to compete with their Chinese and American counterparts. The speculated merger between HDFC Ltd and HDFC Bank is a case in point. The reason why investors are keen to speculate on the merger is because it could create the largest private bank in the country. Now with the banks in India getting big enough to pose systemic risks, the regulator, as expected is getting cautious. In fact the RBI has decided to select few top PSU, private sector and foreign banks as systemically important banks, or SIBs. The top 6 banks that will be designated as SIBs for the domestic financial market will need to have higher capital than their peers. Their key role will be to prevent the financial system from collapsing if there is a crisis. The banks would be required to maintain additional capital in the range of 1% to 2.5% of their risk weighted assets depending upon the order of the buckets. Thus, the SIB classification will ensure that the big banks themselves do not take too much risk on their books. In addition, they will also ensure good health of the system as a whole.

03:10

If power supply is indeed the backbone of an economy, then Indian certainly has a severe back problem. And a stooping back can seldom support a healthy body. Power shortages, disruptive supplies, transmission losses have had far-reaching adverse impacts on the overall productivity in the economy. Will there be an end to India's power woes?

Well, there seems to be some light at the end of the tunnel. The Narendra Modi government has chalked out a mega plan, which if implemented successfully, would ensure around eight hours of quality power supply to agricultural consumers and 24-hour electricity to rural households. The plan is to supply electricity through separate feeders for agricultural and rural household consumption. Moreover, the initiative also includes strengthening sub-transmission and distribution. As per an article in Livemint, the scheme is estimated to require an investment of about Rs 1 trillion. That's 20 times the amount budgeted this year. The investment will be spread over 5 years. The initiative aims to reduce India's aggregate transmission and commercial (ATC) losses by 5 percentage points. Currently, India's ATC losses stand at an alarming 27%. If the initiative is successful in lowering these losses to 22%, it would be enough to recover the investment.

From an investor's point of view, this scheme could create great investment opportunities in the power sector ad well as in ancillary sectors that support the power sector. And eventually, better power supply to farmers and rural households will boost productivity and income. And this could have a strong ripple effect across the sectors.

03:45

It was not long ago, when the Gloom, Boom and Doom Report editor Marc Faber had stated that US stocks need to correct by at least 30% to 40% for investors to make decent gains over a five to ten year period. Essentially, what he meant was that the risk reward ratio was not favourable at all. In fact, Mr. Faber has been bearish on US stocks for quite some time. However, with stocks continuing to rise and being close to their all time high levels, he has been proven wrong for the last eleven months. Sticking to his view nevertheless, Mr. Faber's stance has only gotten stronger with time. He still believes that US stocks could fall by about a third. While he believes that the entire market is in a bubble phase, stocks from the social media and biotech spaces in particular seem to be overpriced according to him.

Trading at about 20 times its earnings, the S&P 500 index's valuations are currently in the higher side of the range it has traded in the past. So, purely going by the not so comfortable valuations, the possibility of a correction cannot be ruled out. However, when and whether the markets would crash by such a sharp amount is something that would be difficult for anyone to guess. Especially considering that this time around there are a bunch of factors (read: excess liquidity) that are playing their part in rising asset prices - and the rise as such is not purely limited to earnings growth and quality.

04:15

In the meanwhile, the Indian stock markets have stood flat after soaring high in the morning session. The mid and the small caps have underperformed the benchmark indices. At the time of writing, BSE-Sensex was trading higher by mere 2 points (+0.01%). Majority of the sectoral indices were trading in the red with realty and auto stocks facing maximum selling pressures. The Asian indices have been trading mixed. However, Chinese and Australian markets have witnessed a healthy rise. European markets on the other hand have stood cautious in the opening trading session.

04:50

Today's investing mantra

"The stock market is a no-called-strike game. You don't have to swing at everything--you can wait for your pitch. The problem when you're a money manager is that your fans keep yelling, 'Swing, you bum!'" - Warren Buffett