»The Honest Truth by Ajit Dayal

Making India Grow Again
7 OCTOBER 2019

There is a fable about the three blind men who, upon touching an elephant, are asked to describe it.

Without access to reliable statistics, those responsible for describing our economy are like the three blind men. And, hence, it is of little surprise that those responsible for managing the Indian economy don't quite know what they are observing and, by extension, are ineffective in making the elephant run.

When provoked an elephant can charge, but you must first know how to rekindle the animal spirits.

Stepping back to describe the elephant

The Indian economy's woes began with the BRIC mania circa 2005. Goldman, Sachs - and others who jumped on the band wagon waving plastic wands - were probably smoking non-tobacco items when they spread the gospel that India was on its way to being a super-power. It is also possible that their mouse pad must have been awfully slippery allowing analysts to click and drag the hallucination-induced models created on xl sheets all the way to a starry-eyed nirvana.

When you tickle your beloved dog on its stomach it lies there helpless, waiting for the next round of pleasure. So it was with our very own Dream Team who - then at the centre of global attention and being toasted at every boondoggle seminar from Davos to the World Bank to IMF - did little to build a large, robust pipeline to accept long-term capital and ensure that diligent capital is deployed in a sensible way. Prior to Lehman's collapse, over 50% of all money entering the Indian stock markets was unknown and unidentifiable pools of speculative money - this was the money that came in via Participatory Notes. Thanks to these opaque P-Notes, India would have ranked number one in an Ease of Laundering Money Index.

Surging stock markets and a strengthening Indian Rupee numbed the UPA-1 into believing that India was the greatest show on planet earth. When Lehman collapsed on September 15th 2007 the earth fell from under their feet as India stood exposed to speculators who redeemed their play money to home base. The Indian Rupee tumbled by 25%, stocks collapsed by over 50%, and interest rates increased. But, the problem was not so much the decimation of the capital markets as much as the devastation that was about to happen in the real economy. Prices of stocks and other assets, as the saying goes, can turn on a dime. Sentiment and signals can turn the mood of markets overnight. But an economy in trouble needs application of mind and a proper game-plan to come out of its rut.

The BRIC fairy-tale resulted in every company dreaming up a business plan to match the expected consumption demands of a billion heartbeats. India was Shining, Rising and Resurging. Monies raised during the 2005-2008 BRIC madness had allowed companies to invest in factories. This meant that capacity across most products from cement to steel to consumer durables increased by over 100%. And with that came the launch of millions of square feet of residential, commercial, and retail space. The investment boom had created more jobs and salaries were increasing by 15% per annum. The salary earner, it was logically assumed, would be able to buy a bigger and more expensive homes and shop at malls.

However, by 2012/2013 when these factories were ready to produce from their new production lines and when the malls and housing complexes were ready, the world had changed - and India had changed.

Many companies which built for the export market or made acquisitions in Europe and the US to capitalize on the genius of the Indian super power and the much-hyped "jugaad" were left with insolvent businesses. After the Great Fraud of the Financial Services industry that blew up societies and countries, consumers across the world had decimated incomes and depleted wealth. Within India, a few cronies were allegedly raking it in under the rule of the UPA-2 but the economy had lost the broader engine of investment from a wider range of companies. Meanwhile, the government was hamstrung by high oil prices, high food prices and a growing subsidy bill - all of which resulted in higher inflation, a weaker INR and higher interest rates. India needed foreign capital and/or government spending to grow.


The BJP-led Opposition stalled every reform of UPA-2 from GST to Aaadhar to FDI in retail and insurance to privatization of PSUs. (The BJP electioneering speeches promised the removal of Aadhar and the Mahatma Gandhi National Rural Employment Guarantee Act). The stand-off between the corruption-riddled UPA-2 and the adamant Opposition resulted in "policy paralysis". The wounded elephant was left to bleed. Every doctor knows that the longer you delay the application of cure, the worse the wound gets - and the longer it takes to revitalize the energy in the patient.

By 2014, the ab ki bar Modi Sarkar, cruised its way to a thumping victory saving India from the misery of Congress-led misrule.

Sadly, not only did the Modi government fail to identify that the elephant was wounded and needed nurturing, but it contributed to crippling the elephant further by the act of demonetization and by a poorly implemented GST. Social and religious diktats (banning the slaughter of cows, women should not visit bars) had a further impact on the local economy and on tourism. About a third of all leisure travel in the world is women travelling with other women. India went off their radar.

The debasement of statistical data and subversion of the autonomy of institutions like the RBI are not unique to this government. Previous governments and Finance Ministers have also run roughshod over conventions and systems. But this time around, India was already suffering economically and, because the blind men thought the elephant was a tiger they expected the animal to roar to life by trying to paint a few stripes under the banner of reforms. In fact - the elephant was further crippled. The introduction of the Insolvency and Bankruptcy Code, 2016 to take bad actors to task was implemented under the BJP-1 government.

The RBI bells the cat

While the BJP-1 government created havoc in the economy by its unplanned introduction of demonetization without fully understanding the impact on the economy, the RBI was focused on ensuring the banks were accurately categorizing their good, suspect and bad loans.

For decades, most Indian industrialists behaved like spoilt children in a candy store with no supervision: they got as much money as they wanted, at the price they wanted, and kept the money for as long as they wanted. Biographies on most Indian industrial families swoon over their legendary business acumen and brilliance. More honest accounts of India's economic history would probably infer that most of the Indian tycoons mastered the art of gaming the system - their brilliance was in capturing favours from regulators and the government and then massaging the palms of the bank officials to fund the implementation of those favours. With decades of this "you scratch my back and I will scratch your back" mastered into an art form under the open hand of the Congress and other regimes - and a motley collection of state governments granting local favours through cooperative banks - the banking system had accumulated a lot of non-performing assets, or NPAs. Money the banks had lent would never come back either because the money was spirited away or because it was used to fund a business idea that failed.


So, after the collapse of Lehman and the Great Fraud of the Financial Services industry, all the monies that were invested in real estate, steel plants, cement plants, overseas acquisitions - looked very shaky. And banks that had lent into this BRIC story of India being a super-power were staring at defaults in their loan book.

In tandem with the Bankruptcy Code, the RBI started to ask banks the tough question: show me your real NPAs and classify debts as bad if they have failed to pay interest on time. The RBI wanted to stop the practice of ever-greening of loans. No more lending Ajit money in a different company so that Ajit can use the money the bank just lent him to repay the bank some of the money due from the company in trouble - and show up as a good account.

The genesis of these wounds on the elephant, suggest that the Indian economy has many problems:

  1. There is excess capacity of many products, so no one is really investing in new factories. If a steel plant is running at 65% of capacity utilization there is no reason to build a new plant or even contemplate building a new plant. In most industries, a CFO or a CEO will only consider a new investment proposal for discussion at the Board level if their existing capacity is over 80% and, with their current cash flow, they can currently service all the interest due on their loans including the repayment of the original loan. With a 65% level of capacity utilization, they know there is a large amount of excess capacity that still needs to be matched by demand.
  2. Investment in factories results in employment creation, (unless you hire only robots); so once the investment in a new factory commences, then jobs will be created; once there is competition for skilled personnel to manage the new factories and the growing business, then salaries will increase. As of now, there is no more investment - which means that no new jobs are being offered. With no new jobs being created and more people willing to enter the work force, individuals feel that their existing jobs are at risk and their salary levels will probably inch up slowly as long as the economy continues to drift downwards. In the BRIC mania there was an assumption that salaries would increase by 15% every year - for the past five years that has not been true.
  3. There is excess real estate inventory; a recent report by real estate consultancy firm Liases Foras, as quoted in Business Today, said there are 1,319,793 unsold residential units with a total selling price of INR 9.4 lakh crore (USD 140 billion) - so new projects are not being launched. Construction is a key to employment creation but if the existing stock of apartments is not being sold why would the developer launch new townships? Moreover, the banks have already lent money to these developers sitting on unsold inventory. Their NPA levels are rising as the real estate sector defaults. That default reduces the banks' ability to give more loans. If money is not available or if the mahout, the caretaker of the elephant, is unable to prod along the elephant, how can the elephant be inspired to get up and start running?
  4. Agricultural incomes are low - a large number of people in rural India were hit the hardest by the demonetization. This is corroborated by the fact that bail outs to farmers under loan-waiver programmes or under the MNREGA schemes have surged in the past few years. Rural India is also affected by the fact that millions of cows are roaming around the countryside as they are too old to be of use to their owners and too expensive to maintain. It used to be that the Dalit ate the meat and the Muslim cobbler used the skin for leather - now there is no "economic" value to Mother Cow and she roams aimlessly across the countryside. The announcement that the state and central governments will build cow sheds is a good step and not only will Mother Cow find a warm and welcome home but the act of creation of cow sheds will add to some economic activity as the government will need to fund this.
  5. The global economy is weak. The trade wars between USA and China, higher tariff barriers, tightening immigration rules, and the general fatigue over the longest expansion in economic history in the United States, suggests that Indian companies that built for the export market will have more challenges.

To make India run again

If this is the true state of the problem, if this what the elephant looks like today, then there is one clear solution: Get real estate to move again.

In 1994, I was at Bush Betta in South India. The open air jeep meandered around a corner and, suddenly, we were face to face with a herd of large elephants about 30 metres away. They stopped, they turned towards us and then, within a few seconds, came charging at us....I was told later that the fact that we had appeared out of nowhere made the matriarch angry and she led the charge. We revved up the engines and moved slowly towards the herd...hearing the noise and seeing us moving towards them, the herd backed off.

The sight of the elephants looking at us and the frightening, yet majestic, power of their surge is something I will always remember.

India, too, can charge by clearing out the unsold stock on real estate which is valued at Rs 9.4 lakh crore - this is 7x the estimated cost of the recent income tax reduction. This is a 7x injection of morphine to eliminate the pain of the elephant and encourage the economy to break out of its depression.

Sending WhatsApp messages that Indians can buy property in Kashmir now that Article 370 has been moved aside will not revive the economy - or the sentiment towards business.

The simple 4-step agenda to clear the property market will cure this sick elephant.

  1. The government should announce that there will be no GST or stamp duty on any property transaction of a ready-to-use building with an occupancy certificate issued before December 31 2020 - as long as the property transaction is lower than INR 8 crore. 90% of all property falls under this category (see Table 1 above).
  2. Furthermore, any developer who has unsold stock (over and above a max limit of 10% of total number of square footage in a project) will not be eligible for any financing from any bank or housing company and will have no access to the capital markets - local or foreign - till such time their level of unsold stock is less than 5% of each project that they have built and launched.
  3. Any unsold stock held by the developer as of calendar year-end starting December 31, 2019 will incur a 10% holding tax payable by the developer at the beginning of the next calendar year;
  4. The government and RBI (in any case one controls the other) can also state that any loan given to properties in the past will not have to be marked down in value due to a market decline caused by fresh sales - and no existing borrower will be asked to top-up their equity if there is a price correction in the value of the underlying home against which a loan was taken.

The impact of 1, 2, and 3 will be like a left hook, a right hook and an upper cut knock-out punch from the legendary Muhammed Ali.

Developers will scramble to clear inventory.

They will have to cut their prices by 20% to 30% - they will have to clear their unsold inventory by December 31st 2019 or there will be a 10% tax on their empty units starting January 1, 2020.

The combination of this reduction in price due to a financial squeeze on developers who will no longer have access to borrowed money and the elimination of GST and stamp duty will see a 25% to 35% price cut in the unsold inventory.

Sales will be brisk and the unsold units could be cleared within 2 years.

Similarly, with the objective of not adding more stress to the banking system, housing finance companies and banks will not be asked to mark down their portfolio of flats to match the newer prices. The old buyers and lenders will be grandfathered into old norms for lending and provisioning. No more NPAs from mark-to-market due to this distress sale caused by a change in government laws.

From the perspective of the banks and the NBFCs, their estimated INR 2 lakh crore of loans to the real estate sector which are sitting on their books will see a release of monies coming back to the banks. Inflow of cash - even after writing down the loans to developers to some extent - is far better than having a zombie loan on the books. Cash is king.

The economy will get a major fillip because when you buy a new flat, you furnish it.

You buy new things for your new home: cutlery, crockery, sheets, furniture, TV sets, oven....

And you get a parking space: so you may buy a new car or a 2-wheeler.

All this buying activity means that consumer are taking things off the shelf from the stores and the showrooms. A dealer or retail shop keeper then orders more goods to stock in their stores. Factories are producing more goods to replenish what has been sold by the dealers and the shops. The classic inventory build-up cycle begins and capacity utilization increases. At some threshold level, the CEO and CFO take a proposal to their Board to build a new factory or expand the existing production line because now they see the improved cash flows from the existing operations. This new expansion of capacity adds to job creation...and incomes increase, and spending power increases. And the elephant is off and running... charging onward.

Moreover, with apartments being sold, developers will again begin to invest in land and start new projects - chastised by their past experience, many fly-by-night developers will vanish and a more organized industry will survive under the aegis of the RERA. New real estate development increases the demand for cement and steel - and labour! People will have jobs and incomes at the lower end of the economic ladder.

From the government's perspective, it already has low GST collection today from property sales of newly constructed units. Because of this policy it will get no GST on the Rs 7 lakh crore (assumes a 20% decline on prices quoted in the Liases Foras report in Table 1 above) of property that may be sold. But the banks it owns now see capital coming back as flats are sold and money heads to the banking system. It needs less money to save the banks. But more importantly, the buying of goods to keep in a new home generates GST. Let us assume that people will spend 20% of the value of the flat they buy on the goods to be added in the flat (and a 2-wheeler or car), so that is Rs 1.4 lakh crore of spend. With an average GST rate of 12%, they collect Rs 17,000 crore on goods purchased for the new property. For now they are collecting close to nothing - no one is buying the unsold property (that is why they are unsold!) and no one is buying anything to furnish the flat - because they have not bought the flat!

Feeling the pain

The pain -and financial cost - will be felt most by the developer and, in many cases, by the politicians who may control, fund or own these developers. After decades of extraction from the aam aadmi, some pain will not make this land-owning class poor. There is little empathy for a business group that has, generally speaking, done very well out of its connectivity.

The reduction in personal income taxes - a bold move by the Finance Minister - is estimated to cost the government (actually this is not government money but money that belongs to all Indians and being decided how it is allocated by the government - so it is "our" money) Rs 1.4 lakh crore. This is 15% of the value of the unsold properties as per the report above.

On September 23rd, Business Standard reported that the gain to 666 promoters from the spurt in share prices - during the first trading day in the stock market after this tax cut was announced - was INR 1.33 lakh crore. More worryingly, noted the Business Standard article, 21 of the 666 promoters got 66% of the gains. So it really may be a transfer of wealth from one large section to a small section of people.

It is possible that this enriched Group of 666 will buy out the 5,765 ultra-luxury properties for the total cost of Rs 91,227 crore and still have some change left to fly their interior designers to Dubai and Milan to furnish the properties. It is more likely they will buy apartments in Singapore, Dubai and London.

The trickle-down effect is a hocus-pocus theory that will not work. Giving largesse to the rich will not get the economy to get out of its slumber and zip to life.

If the blind men could only feel that this is a wounded elephant, they would do a surgical strike like no other. A surgical strike that does not need cloud cover to be successful.

A surgical strike - unlike the one on Aarey Forest, where the BMC chopped off 1,500 trees under the stealth of darkness. (Aarey is not designated as a forest because it fails a man-made definition! It is possible that most humans would fail the definition of human if nature had to define what a human was!)

This surgical strike to Making India Grow Again can be done in broad daylight, when the world is watching!

If there is a silver bullet to cure the elephant this is it: impose conditions that clear the unsold stock of real estate and get people to consume again and put the economy on a virtuous cycle of growth and fulfill the promise of Sabka Saath, Sabka Vikas.