Why India must get real on real estate

So well is this understood now that the Democratic candidates for president have universally called for greater regulation of mortgage markets in the US. In their debate last week in Nevada, they were in agreement about this, disagreeing only about who called for it first. (The Republican candidates, true to form, seem to think that a tax cut will solve the problem.)

It is puzzling, therefore, that once again we in India seem to believe that our remaining regulatory apparatus and our manifest destiny ofincome growth will protect us from a similar slowdown domestically.

Indeed, we are eager to import similar securitisation methods.

In many ways the regulators have indeed attempted to stand in the way of these efforts. For instance, SEBI has announced new accounting standards for real estate; and the RBI launched a major study of bad loans in real estate in end-2007. This, however, came after loans of under 20 lakh had their ‘risk weight’ reduced in the last Annual Credit Policy, increasing banks’ incentive to lend to small borrowers with minimal collateral.

The other half of the problem is illustrated by a glance at the comparative figures for Asian real estate markets. India’s payment-to-income ratio is moderate even though the maximum permitted loan-value ratio is the highest in Asia. In essence, this is explained by how we predict the future income of the borrower as well as future house prices, which is where our cheery national optimism comes in. Voices of caution, such as Fitch Ratings’ recent report that a decline in property prices in India might be problematic, are few.

These expectations, especially of future prices, are partly because historically you didn’t lose money betting on stable real estate prices in India unless you had particularly bad luck — such as buying in Punjab just before Bhindranwale or selling in Gurgaon just after prohibition, to choose examples with which I am unfortunately personally familiar. We have never seen malls fall derelict because a large retailer has downed its shutters, or watched as a freshly built neighbourhood stumbles into steep and sudden decay when half the new homes are foreclosed upon. Unlike most other economies, the presence of a salaried class largely insulated from risk together with a history of stringent land-ceiling laws mean that real estate prices have hardly ever fallen; we no longer have that safety net, but our intuition has not adjusted accordingly.

Financial intermediaries are taking advantage of this: in the past few days Lehman Brothers announced that it would securitise an investment by an Israeli consortium, Deutsche Bank — the largest single loser in the American meltdown — which announced its first set of operations in the Indian housing market; and ICICI announced a real estate fund targeted especially at NRIs. The wealth management corps of banks are pushing funds of housing securities as well. Such efforts are dependent on our apparently unquenchable optimism; we have finally accepted that the Indian economy is, like all others, affected by what ails the American economy, but we do not accept that what ails the American economy could ever be repeated here.

Confidence in the future is often a self-fulfilling prophecy, especially about infrastructure — but only if all involved share it. Unless dour foreign institutional players, for example, believe as strongly as we seem to that a shining future with gleaming new shopping centres and sparkling new exurbs — all paying for themselves — is within our grasp, our very confidence might let us down.

The writer is a Delhi-based economist and political scientist mihirsharma@post.harvard.edu