High price not EMIs: Dear Mr Jaitley, here is why Indians are not buying homes
High price of properties it the main reason home sales have slumped, a small correction in EMIs will not boost home sales if RBI cuts interest rate
Sometimes I wonder if the finance minister Arun Jaitley has ever heard of Abraham Maslow. Maslow was an American psychologist who among other things also came up with the law of the instrument, which is better known as Maslow's hammer.
As Maslow put it: "I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail."
The idea was also put forward by the American philosopher Abraham Kaplan, when he said: "Give a small boy a hammer, and he will find that everything he encounters needs pounding."
What the idea essentially tries to communicate is the habit of using the one tool for all purposes. In Jaitley's case this tool seems to be a cut in the "repo rate", or the rate at which the Reserve Bank of India (RBI) lends to banks.
In the recent past, he has asked the RBI to cut the repo rate time and again. Once the RBI starts cutting the repo rate, banks will start cutting the interest rates at which they give loans, the belief is.
At lower rates people will borrow and spend more and the Indian economy will grow at a much faster rate. For Jaitley its all about lower interest rates. "Now time has come with moderate inflation to bring down the rates. If you bring down the rates, people will start borrowing from banks to pay for their flats and houses. The EMIs will go down," he said yesterday.
The statement was essentially a continuation of the pressure that Jaitley has been trying to build on the RBI to cut the repo rate. But will it make any difference?
Let's try and understand this through an example of an individual trying to buy a home in Mumbai. In a recent research report the real estate research firm Liases Foras had pointed out that the weighted average price of a flat in Mumbai was Rs 1.34 crore.
I had written a piece around this data in early November showing how expensive flats in Mumbai and other cities were vis a vis the average income of people in living in those cities. One criticism that came in was that the weighted average price arrived at was on a higher side because the data had taken only premium projects into account.
There is enough anecdotal evidence to suggest that is not the case. Nevertheless let's take that into account and assume that the actual weighted average price of a flat in Mumbai is 75% of the price that Liases Foras had arrived at.
This works out to around Rs 1 crore. Let's say an individual decides to buy such a flat and takes on a home loan to do so. A bank would normally give around 80% of the market price of a house as a home loan. So, the individual takes a loan of Rs 80 lakh (80% of Rs 1 crore) to be repaid over a period of 20 years. The remaining Rs 20 lakh he puts from his savings.
The RBI governor Raghuram Rajan in a recent speech said that the average interest rate on a home loan these days was 10.7%. Let's assume that the individual borrows at the average interest rate. The EMI on this loan works out to Rs 80,948.
Let's say the interest rate on the home loan comes down by 50 basis points (one basis point is one hundredth of a percentage) to 10.2%. The EMI on this loan works out to Rs 78,265 or Rs 2,683 lower.
If the interest rates are cut by 100 basis points and the interest rate on the home loan falls to 9.7%, the EMI will fall by around Rs 5,330. So, will an individual who has the ability of making a downpayment of Rs 20 lakh and taking on a home loan of Rs 80 lakh, buy a home simply because the EMI is Rs 2,683-5,330 lower?
An individual who has the ability to take on a home loan of Rs 80 lakh must be making around Rs 1.65 lakh per month(as per the home loan eligiblity calculator available on www.hdfc.com). And that is clearly a lot of money. Only a small set of individuals make that kind of money, even in a city like Mumbai.
The same exercise can be repeated for other cities as well, and the results will remain the same. The larger point is that the fact that Indians are not buying homes has got nothing to do with high interest rates and EMIs and everything to do with the fact that homes are atrociously expensive. And instead of asking the RBI to cut interest rates, Jaitely should be looking at ways through which home prices can be brought down to more reasonable levels.
He could start with ensuring that better data on real state is available to the people of this country.
Currently, the National Housing Bank has the Residex index, which gives some idea of the prevailing price trends across various cities. But the information is not up-to-date enough to be of much use. As of now, the data is available only up to June 2014. Also, the data is declared every three months. Something of this sort should be declared on a monthly basis.
Further, anyone trying to buy a home essentially has no data that he can look at to figure out what the prevailing price trend is. Typically, he has to go with what the brokers tell him. And brokers are not normally thinking about the best interests of the individual trying to buy a home.
For starters, the government could try and aggregate the stamp duty data from the twenty biggest cities in India. This will tell us the average price at which "homes" are "supposedly" being sold.
Along with that the number of transactions being registered will give us some idea of what the demand situation is.
Of course, given the black money transactions that happen in real estate, the average price that we get through this route may not be totally correct. Nevertheless, this is not a bad starting point.
Further, in order to cut down on black money transactions the government needs to ensure that the circle rate is close to the prevailing market value in any area.
A property when it is sold needs to be registered at the actual transaction value or the prevailing circle rate, whichever is higher. The stamp duty needs to paid on this value. Typically, the market rate tends to be much higher than the prevailing circles rate. This essentially leads to a situation where transactions are declared at the circle rate and not the market rate, ensuring that a significant part of the transaction happens in black. It also leads to lower tax collections for the government.
Further, in areas where the difference between the market rate and the circle rate is high attract a lot of black money. As Anuj Puri chairman and country head, Jones Lang LaSalle India, told Mint in September 2014, "Reduction in the gap between circle and market rates means that the region becomes less attractive for those who are seeking to offload unaccounted-for funds, and more attractive for genuine buyers."
These are the steps that Jaitley should be thinking about instead of asking the RBI to cut interest rates almost every time he speaks.
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