Demonetisation Could Trigger a Subprime Crisis in India - The 5 Minute WrapUp by Equitymaster
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Demonetisation Could Trigger a Subprime Crisis in India

Nov 25, 2016
In this issue:
» Unemployment, a harsh wake-up call
» Is demonetisation really worth it
» Update from Daily Profit Hunter
» ...and more!

00:00 Chart of the Day

Richa Agarwal, Research analyst

It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of light, it was the season of darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way ....

Never before have these lines by Charles Dickens resonated so well with our country as they do now... a time that will be famous (or infamous) for demonetisation. Views on present and future are divided and uncertain. Only time will tell if the Indian economy got a shot in the arm...or shot itself in the foot.

But one sector shaken in no uncertain terms is real estate.

Rs 8 lac crore - that's the value estimated to get wiped out in the next six to twelve months of sold and unsold residential properties by developers in top 42 cities since 2008... as reported in an article in Economic Times. The move could indeed be a big shocker for the real estate sector.

Demonetisation Could Mark the End of Steady Growth in House Prices


It's a well-deserved blow to those who evaded tax and used unaccounted income to buy property. Yet, the common man who paid tax, employed his deposits and savings, and used 'white income' to buy a home will be hit worse: Not only did he pay tax, but now the value of his home is eroding because of those who didn't.

Real estate developers are worried. Those aiming for buying a house in the near future are hopeful that homes will be more affordable now.

We believe that the situation could be worse than what is projected.

Here is a scenario...

Unlike stocks, with real estate, there is no concept of intrinsic value. The lack of clarity on 'intrinsic value' amid the cash crunch could lead to a long down cycle.

If that happens, related sectors won't be spared.

We already have 60% of the banks burdened with non-performing loans that are at historic highs. The banks and NBFCs may claim that their loan to value ratios are within limits. But most of them are over exposed to the realty sector thanks to the system of dual financing. With sector already reeling under the bad debt crisis, this could be the proverbial last straw to break the camel's back.

In fact, the banking and real estate sector crisis could lead to a domino effect that topples other sectors...and ultimately, the economy.

Layoffs, wage cuts, project delays, bad debts, a consumption slowdown...prepare for a long, vicious cycle. Our worst fears may yet come true.

If this sounds farfetched, remember that it was a house price correction that led to the subprime crisis in the US that still haunts the global economy. While mortgage-backed securities may be less severe in India, black money has created a similar bubble in housing prices.

Yes, demonetisation could lead to the long-awaited correction. But impact on affordability could be worse. And if you think low interest rates will help, ask yourself if they've helped shake the US economy from its comatose state.

This scenario may or may not unfold. But it is our job to present the possibilities, even if they aren't pleasant.

There is no denying that the months ahead could be times of chaos and uncertainty. So look for the safest stocks that could tide over the temporary chaos and yet benefit from the huge earnings upside in store over long term.

03:45

Successive governments have failed to create adequate jobs in the country. As higher number of youth enter the workforce each year chasing limited number of jobs, India's demographic advantage faces a threat of turning into a disaster. A widespread retrenchment in existing jobs has further compounded the problem. The recent layoff of 14,000 employees by engineering giant L&T is a harsh wakeup-call. The move is being downplayed as a cost-cutting exercise amidst a slowdown as the company has been increasingly resorting to sub-contracting for executing its orders.

Whatever may be the reason but the fact of the matter is that rising unemployment can no longer be pushed under the rug. To make matters worse, factors such as automation and digitisation are rendering a lot of jobs redundant and its heat is being felt across industries. Therefore, unless the government takes concrete steps to create more employment in the country, it can have far-reaching consequences for our economic security in the future. Vivek Kaul has detailed down its impact on the common man in a note. His insightful analysis is worth a read.

04:20

Even as the country continues to grapple with growing unemployment, demonetisation is likely to further add to its woes. Demonetisation is being hailed as the panacea to suck out the black money from the system. But the move comes at a cost to the economy in terms of loss in productive time involved in exchanging old notes as also the fall in consumption impacting the financial health of companies. The cost has been quantified at Rs 1.28 trillion by economic think tank, Centre of Monitoring Indian Economy (CMIE). And the largest cost of Rs 615 billion is likely to be borne by the business community.

India Inc is being constrained by its inability to liquidate stocks and receivables into cash as households reduce discretionary consumption spending till 30th December. This in turn is expected to depress the capacity utilization of manufacturing companies and manifest in the form of slowdown in hiring and investments in future. For an economy struggling to revive demand, whether the economic and social costs of demonetisation will outweigh its benefits to curb black money is something to watch out for.

04:30

Meanwhile, my colleague Apurva Sheth, editor of Swing Trader, just sent us his view on the market correction.

A Chartist's View: After The Drop Comes The Chop

The last few days have been eventful. When all of us were nail-bitingly waiting for the US presidential elections, our PM announced a ban on 500 and 1000 Rs notes on November 8. Markets are on a roller coaster ride since then.

Nifty opened with a loss of 500 points immediately after the announcement and recovered all the loss in just one day. But that wasn't enough, the index gave up all these gains and slipped lower even below the low of 8,000 which was hit on November 9. All this may look unusual to a new trader but let me tell you it is quite normal: after the drop comes the chop.

During this week, index has mostly traded in a range of 7,900 to 8,000. This range could act as support in the immediate term. Medium term supports are placed around 7,760 to 7,810 levels. To keep a tab on the index, you can read our weekly commentaries on Global and Indian Indices, commodities and currencies. Such markets also present with excellent trading opportunities. You can sign up to the Daily Profit Hunter to learn more about such ideas.

04:45

After opening the day flat, the Indian stock markets have surged. At the time of writing the BSE-Sensex was trading higher by about 368 points (up 1.4%), while the NSE Nifty was trading higher by 125 points (up 1.6%). All the sectoral indices are trading in the green with IT and pharma witnessing maximum buying interest.

04:55 Today's Investing Mantra

"Predicting rain doesn't count. Building arks does". - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Richa Agarwal (Research Analyst) and Madhu Gupta (Research Analyst).

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5 Responses to "Demonetisation Could Trigger a Subprime Crisis in India"

Raja

Nov 29, 2016

The author has no idea what triggered the sub prime crisis.

Like 

Dhir Bhateja

Nov 28, 2016

Excellent analysis just hoping cash component in home loans may save us an indian subprime mortgage situation

Like 

SRINIVASAN CHANDRASEKHARAN, BAHRAIN

Nov 26, 2016

A very well and lucidly presented article by RICHA AGARWAL on the big shocker for the Indian real estate sector. As she has rightly said, the shock would be further magnified with the existing dual financing in real estate in India. Consequently, what she said that the Banking and Real Estate Sector crisis could possibly lead to a domino effect to topple other sectors and ultimately the economy is a possibility undeniable. It is not unlikely that it can snowball into a crisis of the magnitude of the subprime in US as she has aptly put it.

Like 

Rajesh

Nov 26, 2016

What a contradiction , on one side you are talking about subprime crisis & just below you are telling us that sensex is likely to touch 40000. According to HFC, they have enough factor of safety since they finance only the official part of the deal. Erosion of value will be at the borrowers end and not at lenders end. Do you think that real estate will correct by 30% ? black money is not part of formal economy so does not contribute

Like (2)

Chandrashekhar Vaidya

Nov 25, 2016

You have listed only one of the factors leading to sub-prime crisis, namely drop in property prices. However, there were other important factors such as:
a) Mortgages were extended to also those who had did not have sufficient capacity to repay. New mortgages were given when prices went up, thus reducing the buffer available between the mortgage amount and the value of the property.
b) In USA, the housing finance companies did not have recourse to other assets of the mortgagee. She could simply give up the house and become debt-free.
c) Due to the role of black money/cash, the actual disbursement of housing loans is substantially lower than the original cost of the house which itself has gone up substantially over the years. As per your chart, the highest growth in value is in Delhi where the ratio of cash is also the highest.
d) While USA is a spending economy, India is a saving economy. People here don't take top-up loans to spend away on consumption.

Due to these differences between USA and India, I think the probability of sub-prime like crisis is quite remote.
However, it does bring out an important point: Howsoever desirable something maybe from the long term point of view, disturbance in the short term can be litterally killing for the unfortunate.

Like (1)
  
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