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7th Pay Commission to Heal the Wounds of Indian Real Estate?

Dec 12, 2015

In this issue:
» What does IIP data suggest about Indian economy?
» Bad debts force banking system to adopt tough measures
» Market roundup
» ...and more!
0:00
Rahul Shah, Co-Head of Research
  • Rahul, you know what, I think my woes are about to end. The recommendations of the 7th Pay Commission couldn't have come at a better time.

That was a friend of mine, a small real estate developer, calling in to share happiness. His business has been on a slippery slope of late. Sales are down and interest obligations are getting difficult to meet. But with the pay commission recommendations likely to provide a much needed stimulus to various industries, including his, he is hopeful things will change for the better.

He is not the only one expecting a turnaround in real estate.

The Indian Express recently quoted a Credit Suisse report that seems to have come to the same conclusion. It expects the real estate cycle to be up and running in small towns. After all, it is here that more than 80% of the central government employees reside.

Of course, the recommendations will have a trickledown effect across all sectors. But the reason we are talking about real estate more is because of a statistical quirk. A good part of the households stand at an inflection point wherein a hike in salaries could lead to a disproportionate rise in housing spends. The number that's doing the rounds is 3.1x. In other words, a certain number of households could see a three-fold-plus jump in the amount they allocate to housing. This is a big positive for the real estate sector in small cities.

Let's leave real estate aside for a moment and try to answer a broader question: Does economic stimulus help improve GDP growth?

Well, this is a tricky question. One cannot have controlled economic experiments. That is, one cannot conduct two different experiments at the same time (one where stimulus is provided and the other where the government cuts expenses) and then compare results.

However, ample studies from around the world argue that by cutting expenses, and thereby reducing deficits, economies have seen improvements in real GDP growth, both near and long term.

And the reason isn't difficult to understand. We are of the view that the private sector is typically a better and more efficient user of capital than the government. It can extract more from every rupee at its disposal. And for every one rupee the government takes away from the private sector, the private sector has one rupee less with which to deploy and create wealth.

It brings to mind the analogy of a benevolent father who tries to improve the lot of an inefficient son by taking money from his efficient son. Here, not only will the inefficient son fritter away this money, the efficient son has that much less money to put to productive use. The end result? The family wealth will be worse off than before the reallocation.

A nation's economy, we believe, is no different. The more the government spends without a concomitant improvement in productivity, the worse the damage in the long run.

Now, the real estate sector will no doubt see an immediate improvement in demand, as more income will come into the hands of government employees. However, the sector would do well to curb its enthusiasm. The quality of this demand would be better if it were a result of genuine job creation. If the economic logic we presented has any validity, the demand burst the sector is likely to witness will be short lived.

Also, we are not sure if the country's current realty prices are market clearing.

As The Daily Reckoning's India Editor Vivek Kaul points out, the major reason Indians are not buying as many homes as they were in the past is because prices are too high for most people's income. Even with Pay Commission's proposed hike, we're not sure this will change.

What do you think? Do you think the recommendations of the 7th Pay Commission will provide a boost to the real estate sector in India? Let us know your comments or share your views in the Equitymaster Club.

By the way, we hope you've been able to go through the insightful Real Estate guide that Vivek Kaul has put together. If you haven't already, get your copy now by clicking here.


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2:30 Chart of the day

The month of October has turned out to be a good one for industrial production. The index of industrial production (IIP) grew 9.8% in October as compared to 3.8% in the preceding month. Essentially, this is a 5 year high. But is this sustainable?

One of the reasons why this number has been so good is the healthy demand for consumer durables and that too during the festive season. Post the festive season, there tends to be a lull in activity. So there is good chance that such a strong performance will not spillover to November. The other reason why November numbers could be subdued is the high base effect last year.

So in that sense, the strong set of numbers in October could be a one-off. Basically, one cannot take a call on IIP based on one month alone. The trend will need to be tracked over a period of months to determine whether there is really a strong recovery taking place. For the government though the October numbers will be something to cheer about.

A real recovery or statistical aberration?

3:30

Recently, RBI Governor, Raghuram Rajan, has warned the corporates to avoid over-borrowing. Further, he went on to say that over-borrowing is like 'dynamite' which can harm at times with its explosive nature.

The statement comes at a time when stressed assets ratio of banks in India as a whole stood at 10.9%. This means that for every Rs 100 given out as a loan, Rs 10.9 has either gone bad or has been restructured. This is clear indicator that the banking sector in general and the public sector banks in particular continue to remain in a mess.

To add this, interest coverage ratio (ICR) of the corporates have deteriorated. ICR is a measure of a company's ability to honor its interest-payment obligations. ICR of BSE-Sensex companies has fallen from 10.56 times in FY11 to 5.63 times in FY15. To make situation worse, ICR of BSE-Small Cap companies has fallen from 3.03 times in FY11 to 1.33 times in FY15. As such, RBI has prepared a database of large borrowers whose status of borrowings has been shared with the banks. This will enable the banks to be more careful while lending to these large borrowers.

While this is indeed a meaningful, it is time that banks and policymakers become proactive and give a serious thought to bringing some positive changes in the way Public sector banks operate. This is because no economy can be strong unless it enjoys the support of a strong and healthy banking system.

4:15

Major global markets witnessed strong selling pressure and consequently have closed on a weak note in the week gone by. Weak crude oil prices and worries about the US junk bond markets rattled the US indices. The oil prices have touched new lows.

Fears of slowdown in China also dampened market sentiments. The sell off activity gained ground across European and Asian indices.

Among the European indices, stock markets in UK (down 4.6%) and Germany (down 3.8%), led the pack of losers. The sharp correction comes ahead of the Fed decision on interest rates. Uneasiness on expectations regarding the US interest rate hike in a decade have kept the markets at bay. Consequently, various indices recorded steepest weekly losses since August.

Global weak cues also kept the Indian equity markets on edge. The key benchmark indices closed on a discouraging note as selling activity intensified during the week. Barring the IT sector, all sectors ended the week on a negative note. Stocks from metal and realty sectors were the biggest losers for the week.

Performance during the week ended 11 December, 2015

4:45 Weekend investing mantra

'Risk comes from not knowing what you're doing'- Warren Buffett

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

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6 Responses to "7th Pay Commission to Heal the Wounds of Indian Real Estate?"

Prakash

Dec 13, 2015

Real Estate woes can only solved by simplifying the Rent Control Act and restoring the rights to the Owner of the property in case of litigation within a fixed time frame. Giving fillip to the Concept of Renting Homes is another one to be seriously considered the Govt.

Like 

G S Apte

Dec 13, 2015

Hi,

At high level, it looks like that, Real Estate sector would benefit by this 25% to 40% hike (massive hike by even International standards) in the pay of all the government employees. In general, I am of the opinion that, there is no shortage of money in the hands of people, and there are large number of people who do not understand equity as an asset class, and prefer to invest only in gold and real estate. In addition to these people, now government employees who are doing financially well (due to various known and unknown sources of income) would have additional surplus money to invest, and Real Estate sector would directly benefit by this.

It is difficult to say, whether overall economic environment would improve or not. Most of this additional money may not get invested in new business, and equity; so things would be tough for business, unless more transparency and concrete steps are taken by central government to improve investments in the business, roads and infrastructure. On all these three fronts, there is not much visible improvement in past 2 years; and lot needs to be done. Lot is discussed on TV channels but we have not noticed any improvement in Mumbai so far.

We have to wait and watch to see how overall economy and private sector employees and employees from unorganized sectors would benefit by this 7th pay commission recommendations.

Like 

mohan iyer

Dec 13, 2015

you have quoted the figure 3.1 as the increase in emoluments arising out of 7th pay commission. this is misleading as most of these increments are already being given as DA.The actual increase will be only marginal as the DA is being merged to the actual Pay. Similar will be the case in Pension pay out.
Real estate is in bubble state and so are the stock market valuations and the liquidity in cash ($).
The process of shrinking from the excess monetary cycle period, nearly 8 years, has to begin when the cash will be king again. Lot of sufferings due to losses in investments is on the card.




Like 

Parthasarathy

Dec 12, 2015

More money in hand, results either saving or spending. Those who have dropped idea of buying house due to price raise, now they can think of buying flat or investment in real estate. Difinetly 7 CPC will boost economy because Indians are big buyers.

Like 

s.ganesan

Dec 12, 2015

Absolutely not. Unless affordability of common man is increased or the real est. prices come down to reality no boom can be expected

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Sandeep

Dec 12, 2015

7th pay commission and real estate likely come back with outside metro govt babus buying power is a good story. How much can real estate story be linked to corruption bribes reduction?? And black money being tightened. How much were these responsible for undue surge in real estate. Can you provide some study nd correlation??

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