Budget 2015: Jaitley must dissuade second home investments to deflate property bubble

Big Picture: Budget needs redirect savings from unproductive sectors like Real Estate and Gold

India, an emerging market, needs to build infrastructure that is critical for long-term progress. Such initiatives are financed by long-term financial savings.However, government policies have encouraged households to direct large chunk of their savings into real estate and gold Indians are obsessed by these two physical assets that have negligible Incremental capital output ratio (ICOR).  Currently household savings in physical assets are two time of their financial savings, which was almost equal in 2007. Result – banking sector faces capital shortage, government is struggling finding solution to long term capital needs for long dated infrastructure projects, and business in the infrastructure value-chain remain deeply affected. India relies on global investors to fund projects. In addition, there are issues of affordability of housing and equity in taxation across income levels.

Government needs to act now. Radical outcomes need radical approaches.

  • Dissuade investment into second homes

Current income tax provisions promote hoarding of property by investors (not end-users), who now account for more than 50% of property purchases in metropolitan regions.  While it may seem foolish that investors borrow at 10% p.a while only getting rental yields of 3-4% p.a.  The apparent gap is made up by tax incentives for purchase of real estate and classifying it as investment rather than end-use. Section 24 of the Income Tax Act caps the offset from interest paid on mortgage loans on properties bought for the self-use to Rs 2 Lacs. However, for investment properties, the entire interest differential between the interest paid and rental yield and an additional 30% standard maintenance deduction can be claimed as loss from the income. Further, due to low rental yields, real estate investment is currently being used as tax saving instrument.

This in effect is subsidy to rich at expense of poor. It is also substantial loss of tax revenues to the government. Persistent high-inflation and lack of reforms in the opaque real estate sector have contributed to the asset price bubble and attracted more investors. Second homes should attract differential rate of tax. This will cool down the house prices in orderly manner, channelize saving into financial assets, deflate the property price bubble, contain long term inflationary expectation and strengthen the “Housing for All” policy of the current government.

  • Improve land productivity and Tax unutilised land / buildings

Presently government agencies responsible for urban planning and development get revenues from “land monetisation” not land productivity. They derive revenues from new construction and sales, not end-use, via land and stamp duty that now account for 7-8% of state government revenues.As per last census of 2011, vacant houses in the urban areas have increased by 73% to 11 mn in a decade. This has also resulted in prices rising beyond the affordable limits of an actual end-user. Moreover, the developers have started new trend of affordable housing to stay afloat and attract buyers. These affordable houses are located far away from places of work and the end-users are not inclined to move. Most of such locations at 50 Km from city centres are undeveloped and not liveable.

It is imperative to release, develop and utilise land close to urbanising areas.This can be done by imposing vacant land tax, a practice prevalent in developed countries.This will discourage speculative land hoardings and encourage land-owners to develop vacant or under-utilised land parcels or make way for others who can do it. As a result, inner city land would turn productive thus reducing the pressure to build undeveloped sites. This is also similar to progressive tax – paid by wealthy and somewhat reduces economic inequalities.

  • Recycling of Gold by Issuance of Gold

Gold has been asset of choice for over 2000 years – when India was rich and contributed 30% to world GDP. Even today, India is the largest importer of gold in the world, accounting for one third of total consumption of the world. It adds nearly 700-800 tonnes (US$40 bn) each year. About 25,000 tonnes of gold is held by temples, trusts and households.  Gold imports have worsened current account deficit and leading to drain of precious foreign currency from India.

This can be controlled through introduction of small ticket gold bonds. Households across India can deposit their excess gold with banks and take gold bond that entitles them to same amount of gold after certain agreed period and pay a coupon of say 1%-3% p.a. The bank can put the same gold in circulation for sale based to individuals, manage effectively the risk of deposit and demands while   monetize the money generated in long term investment projects. A similar scheme is currently operational but it only encourages gold deposit of more than 500 gms and does not pay attractive rate of interest.

The benefits of successful implementation of this scheme are following; 1) India will get cheap capital to fund long dated infrastructure project rather relying on kindness of global strangers. 2) In absence of a global buyer, gold will settle at much lower prices thereby setting up the positive vicious cycle for the country.  3) Declining Lower prices will reduce the speculative demand as well as resist the conversion of ill-gotten and illicit money in the economy and 4) Improve the Incremental capital output ratio and velocity of money in the economy. Considering Even 10% release of gold from vaults and stockpiles can release $200+ bn and if we add the multiplier the numbers can be staggering.

The physical assets like Real Estate and gold contributes marginally to Incremental capital output ratio (ICOR) of the nation. The time has come to deflate the Real Estate bubble and discourage fetish for Gold consumption of Indian, channelize savings in productive capital formation by investment in infrastructure for the nation. There cannot be a better day to address this issue than Union Budget 2015.

(Manish Bhandari is CEO and Managing Partner Vallum Capital Advisors, a firm in investment advisory. He is available at  manish.bhandari@vallum.in)


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