Speculators Come Back, All Is Forgiven!

The Modi government has played the classical Keynesian card by boosting infrastructure investment to stimulate the sluggish economy. This, in the absence of private sector or foreign investment, at least for the moment, will bring some relief to an economy where there is a degree of scepticism on the growth statistics computed so far. This sarkari booster initiative has come about not a moment too soon, and should, alongside the soft oil prices, start showing further growth at the bottom line shortly.

Infrastructure building may be starting up after a long pause, but the state of the residential and commercial construction industry countrywide is truly alarming.

Organisations connected with the broking, management/security/maintenance services provided to this sector, that nominally accounts for 17% of GDP, such as Magicbricks, Knight Frank, 99Acres, Cushman Wakefield, etc. have put out very disturbing reports.

They, more or less uniformly state, that thousands of semi-built apartments and millions of square feet of built office and showroom space are going a-begging for customers and are unsold.  This is the case in every metro and large city and its environs, across the length and breadth of the country. The secondary market too is very soft, up and down the spectrum, with serious buyers few and far between. Rental rates also, never more than 2% of capital value for residences, and about 7-9% for commercial area, have stagnated or fallen as well.

And the situation is more acute in newly commissioned sectors on the more distant edges of the cities. This is sometimes due to the absence of promised government infrastructure and connectivity, delayed for years in the implementation.

Sometimes, as in the case of Delhi’s satellite town Noida, there is confusion: retrospective rules have apparently been violated, but this is revealed after the flats have been allowed to come up, and millions in home-buyer money has been invested!

The other huge problem currently is the mass exit and total absence of the speculators that used to keep this sector pumped up. This, even as the largely self-funded and loosely regulated construction sector went on a building boom that has the potential, even on a competitive and private basis, to solve a large proportion of the housing and commercial space shortages in the country.

And all of it was self-generated,  the land banks and construction funded via internal accruals and investor money, in addition to bank, institutional, venture capital and informal sources of finance. This was driven by market forces, and a large dollop of optimism, even ‘exuberance’, most recently from 2008 onwards, when the outer world collapsed!

The speculators, alas, have all exited real estate, ever since the returns began to barely keep up with the inflation rate of an estimated 10%. This came to pass sometime around 2013, when the economy slowed to its lowest ebb, and with their departure, the demand scenario promptly collapsed.

The speculators had to leave because the retail cost of capital is at least 10-13% in the banking industry, and more in the informal banking system, and a return of 10% and under, in sluggish conditions, is a net loss, illiquid, and certainly not worth the candle.

The residential and commercial property market, in other words, cannot survive at much under 20% return on capital per annum. Even in a largely end-user market where 80% or more are the ultimate buyers, and the ticket sizes are modest, the rate of return is faltering. This is because it barely keeps pace with  retail inflation at a minimum of  8-10% , even as the most competitive housing and commercial loans, over long tenures, are at rates a tad higher.

And the situation has remained stagnant ever since, though prices have not dropped more than 20% , despite such dismal conditions, because the underlying land prices are persistently high, even as it becomes increasingly difficult to find.

The speculators, ‘financiers/underwriters,’ considered the life-blood of the ‘ construction industry,’ have no choice but to sit tight on their money, living the ‘cash is king’ principle for uncertain times. Or, yes, they are making cautious forays into the stock market.

At least on the bourses, with talk of a ‘long term secular bull market’ doing the rounds, prospects of earning the 20% or more per annum they need to, levels which give them a real return on their capital, are much more likely in the near term. This will most probably result in speculative profits eventually, some of which are traditionally, and will be once more, channelled back to real estate. This is the outlook for some time in the future though, in the cyclical fashion that features in every boom and bust.

The worry is, however, that company earnings are not picking up, and the Modi government is not able to implement its development agenda anywhere near fast enough.

Also, in the interim, the assumption is that the construction industry will receive new lines of credit/ rescheduled debts from the banks and lending institutions to finish their half-built projects. Otherwise, there will be a bloodbath of attrition, a great deal of distress selling, and many of the present prominent developers will have to give way to better-funded newbies.

These cash-rich new players may well buy the half-built assets, leveraged cheap, but will only do so in the expectation of making substantial profits on their investments. The end-user buying community, will not get the 50% slashed prices that they dream of.

The speculators, who are bold enough re-enter the construction market early, will much prefer it if prices rise, because that is how they make money! And a stock market or property market without its speculators, will be hard pressed to survive. It is they who place and pay a premium on the better times to come, without waiting for them to actually arrive.

The entire residential and commercial sector is presently left to the tender mercies of the ‘end-user’, that constitute no more than 15% , on average, of the primary buying community. These worthies, expecting a crash in prices as the crisis deepens, are gleefully seeking ever more unrealistic bargains before committing themselves. To them, the builders are profiteers, bloated on black money, and unethical, one-sided, contractual arrangements.

The builders, their excesses and sharp practices notwithstanding, are flirting with bankruptcy, and the entire house of cards, here in India, as in China, is tottering. This is not going to feel like just desserts at all, when, and if, an implosion comes about; because it will sink a large section of business, industry, banks, and employment alongside.

Combined with the fact that industry, including the populous SME sector, which also accounts for another 17% of GDP, has also been languishing, things are looking grim for 34% of the economy! And this is before counting the rural sector, that houses 60% of the population, including about a fifth of the number actually in farming, and accounts for another, rather paltry, calculated on a per capita basis, 17% again.

Industry is showing drastically reduced profit margins, lower sales/revenues, under-utilisation of capacity, and high debt burdens. It is struggling to service the debt accumulated at high interest rates. Thomson Reuters data cites the example of Hindustan Construction (HCC), which had its stock prices soaring as it was building a bridge to decongest the Mumbai’s daily commute circa 2008. Back then, it owed $674 million, which has ballooned to $1.6 billion in 2014/15, in drastically reduced market conditions.

But what is the government, specifically the RBI and Finance Ministry doing about the high interest rates, the recapitalisation of banks, and renegotiation of all the stressed loans to builders/ industry, which are about to become irretrievable NPAs?

Amazingly, nothing dramatic certainly, even in the face of an impending avalanche  promising financial ruination for a very large section of the economy.

The RBI has reduced interest rates by 0.75% to 7.25% this fiscal, but is reluctant to move faster. This despite the fact, as Reuters points out, that ‘wholesale inflation has declined for eight consecutive months,..and consumer inflation is within the RBI’s target of 2-6%’.

Business confidence in the future is actually plummeting. A recent ASSOCHAM survey, looking back at the April-June 2015 period, with a projection to the July –September quarter, has only 54.8% of the respondents ‘hopeful of improving economic conditions in the coming months,’ down from over 80% a year ago.

The US also toyed with the idea of ‘moral hazard’ which sees retribution for financial excesses as just retribution, before wisely going in for the biggest quantitative easing programme (QE) in history. This, because the US government wanted to avoid another Great Depression far worse than the one seen in the 1930s.

It doled out $85 billion per month for years together at practically zero per cent interest, in order to revive its fortunes. And while the US economy is in much better health now, it is still not out of the woods.

India has a choice to make now, before the situation in three vital sectors of the economy, at least, falls into the abyss. But the window of opportunity is not going to stay open indefinitely.