Sunday, September 9, 2007

Collateral Damage

The unfinished policy business in the Indian realty sector

The discerning financial advisor of mine is a staunch believer in the innate strength of Indian stock markets. And he has been reasonably successful in making his clients believe in his story, as reflected in his ever-expanding clientele (primarily, his clients belong to the salaried class predominantly buying Mutual Funds). At the same time, he strongly condemns real estate investments, for he opines that these investments lack liquidity and that real estate invariably involves black money. He goes on to explain that once an investor decides to liquidate his real estate, then again he receives enormous black money and – devoid of any other alternate investment prospects – he ends up in putting it back in real estate.

I wonder why is it that even an ordinary real estate investment involves ‘black money’ and turns into a disincentivised asset for the salaried class. Well, one reason that experts put forward is the excessive stamp duty levied by respective state governments. In fact, the economic irony is that it is this illogical rate (which otherwise could be a huge revenue source) that offsets the potential revenue earnings at two levels. First, owing to the illogical stamp duties, investors shirk to transact at market rates (in most cases they stick to the circle rates that are in all likelihood much below the extant market rates), whereby paying much less than the actual stamp duties and paying the rest by way of unaccounted money. Subsequently, this unaccounted black money then also escapes the purview of income tax.

In this whole process, it is the commercial bank that has been at a more advantageous position. What has been happening (and interestingly is missed out by popular media as well as regulators) is that most buyers are grossly undermining property value (to reduce their burden of stamp duty) and getting it bank financed; and the banks are actually financing on the registered value (which in most cases is much less than the actual value) and are mortgaging the entire property against the loan. This effectively means that banks are able to secure collateral of much higher value as against the disbursed loan. In all this, if we look at the salaried class, they are forced to borrow the black money in the purchase deal from personal and unorganised sources (often at hefty interest premiums) as long-established banks do not lend black money.

When all is said and done, the government and the salaried class turn to be the biggest losers in this financial game. And in this case, there isn’t anyone to be blamed other than the state itself. If at the policy level, attempts are made to look at the big picture, then this entire predicament can be avoided. Though there are some half-baked reforms attempted hither and thither (stamp duties have come down to 4%-5%, etc etc), they have not done much. And why? Because of the government’s sweep-it-under-the-carpet behaviour. It is pathetic that the government wishes us to now tacitly assume that unaccounted deals made from black money are far more fruitful than white deals! The State has to intervene, with ‘real’ purpose!


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