Let's review some numbers:

1. 5%, the average rate of real growth in GDP under the Modi government(s),
2. 5% - the annual rate of inflation,
3. You combine the two and you get 10%: the "nominal" rate of growth which includes "growth" due to increase in prices,
4. USD 3 trillion: what India's economy was slated to achieve this financial year, prior to the disruptions caused by COVID-19,
5. USD 150 billion: the estimated value of real estate projects completed but not sold, or incomplete and waiting for financing or demand to pick up - for a total of some 1.5 million unsold residential homes of different sizes, at different price points,
6. As per HDFC, total mortgage loans are about 10% of GDP, so about USD 300 billion,
7. HDFC has a loan book of USD 75 billion to home owners of real estate developers (about 25% of the total home loans in the country),
8. As per HDFC data, nominal interest rates on a typical home have collapsed from 13.25% in the year 2000 to 6.90% in 2020,
9. More impressive is the effective interest rate on a mortgage due to tax deductions: this has declined from 12.0% to 2.3%!

With this backdrop in mind, let's look at how one can kick start demand - and GDP.

Unleashing Demand.

On one hand we have people who need homes.

Yet tens of thousands of homes are unsold -or projects are stalled.

A key ingredient, the cost of money (interest rates on mortgages), have collapsed.

So, why are there still so many unsold homes?

Well, for 3 broad reasons:

1. Developers have kept prices high - with their deep political connections, they have managed to get the PSU banks to roll over the loans they owe the banks. They are under no pressure to sell flats at lower / distress prices.
2. Transaction costs are high: the stamp duty is another deterrent and is generally not financed by the mortgage loan.
3. India's NBFC and bank system is under stress: after the bust of IL&FS, the general slowdown in the economy, the bad corporate loans and scandals and the recent knock from COVID the banking system may not be able to cough up the USD 112 billion of funding to individuals to provide the 75% finance to buy out the USD 150 billion of unsold flats sitting with developers. State Bank of India, the largest PSU bank by reach and size, has a total cumulative loan book of USD 115 billion to all its customers - for all sorts of loans, including homes, automobiles, and personal loans. There is not enough money in the Indian financial or banking system to provide the USD 112 billion of funding to individuals who wish to buy a home and would qualify for a loan - provided the purchase price was right.

A market works when a willing buyer and willing seller agree on a price - and when the financing is available to close the deal.

The real estate sector is not a market-driven supply /demand self-correcting business. It has been - and is - a manipulated sector with extraction as its middle name. From land purchase, to zoning, to construction there are many unseen hands in the till. The sector defies the basic laws of a market and is broken - largely because of the political connections of the developers and their ability to "wait it out" because money from a PSU bank was always available for the asking.

So, this is what the government must do:

1. Deny all developers access to local or international loans; all loans due will have to be repaid by their due dates, with no extensions. This will force the developers to raise cash by selling down their inventory - this will cause a 20% to 30% reduction in the selling price;
2. Make state governments waive stamp duty for 6 months (as Maharashtra recently did with phenomenal success).

This will spur the demand side of the equation.

Supply - of capital for home loans.

With demand activated and the supply of properties already in existence, what is missing is the oil to make the engine purr: the lubricant of money. There is not enough capital within India to finance the demand for homes, once unleashed. Giants like HDFC and SBI can barely lend USD 15 billion a year when what will be needed may be 8x of that amount.

But there is enough money in the world to help the engine hum along.

A study by Quantum Advisorssome years ago had indicated a large pool of capital with pension funds and Sovereign Wealth Funds. My estimate is that these two "asset owners" now control about USD 100 trillion between them.

These owners of capital are all looking for returns: for sensible, long-term returns to meet their long term obligations in their home countries. Of this USD 100 trillion of assets, maybe 40% is invested in fixed income instruments. The Japanese will be happy with a 2% return, the Europeans with a 3% return, the Canadians with maybe 4% and the US with maybe 5% return on their fixed income portfolio investments. The problem for these long term investors is that 70% of all European bonds are now yielding negative interest rates and 90% of bonds issued by the governments of the developed world are yielding less than 1.5%. If they invest USD 100 in a 7 year German bond, they get back USD 99.25 after 7 years: they have to pay governments to keep their money! Insane!

The Great Financial Swindle in 2008 - as a result of the failed financial engineering by the likes of Goldman, AIG, J P Morgan, HSBC, and Morgan Stanley - forced governments to reduce interest rates as they bailed out the global economy after the bankruptcy of Lehman.

A sluggish global recovery forced central banks to keep interest rates low. COVID ensured that interest rates will be lower for a long period of time. Hungry for yield, the USD 40 trillion with pensions and Sovereign Wealth Funds could be encouraged to sniff around India.

With the 10-year Government of India bond interest rate at 5.5% - and even accounting for a 2.5% per annum loss in the INR vis-a-vis the USD over the next decade - capital deployed to India can earn 2.5% per annum. That is far more attractive than the minus 0.75% on German bonds. Or the 1% on 10 year US bonds...

The government should allow SBI to launch a new SPV: SBI India Catalyst. This SPV should be authorised to raise up to USD 100 billion from pension and sovereign funds at a maximum 5.5% rate of interest. The money so raised will be deployed to finance home buyers of the low and mid segment (80% of unsold flats are in these segments) at a 7% rate of interest. This will give SBI a 1.5% spread to pay for the admin costs of assessing and monitoring those loans - using our new-found love for on-line since COVID, this is not a big ask. With the National Payments Corporation of India, Aadhaar, and e-KYC a SPV under SBI can spearhead this easily. Brilliant minds like Paresh Sukthankar (who ran risk for HDFC Bank) can assist existing teams at SBI and TCScan adapt the SPV to reach out to SBI's existing 430 million customers - and beyond.

SBI being a PSU bank carries an implicit government halo around it - unlike an HDFC or an ICICI BANK. The creation of an SPV (which should be an NBFC) will allow the new entity to move quickly with limited restrictions - but oversight - from the Reserve Bank of India.

A virtuous cycle unfolds.

The act of homes being purchased will reduce the unsold inventory. At some point in the cycle, the real estate developers will use the cash they have received from the sales of these (currently unsold) homes to invest in new land and set up new projects. This will boost the demand for cement, steel and transportation - and jobs will be created.

The act of buying a new home will result in those homes being furnished and equipped with white goods - with the added possibility of buying a new 2-wheeler or car. Again: the creation of demand.

As all these transactions kick off in a virtuous cycle the government will collect GST. Money lost on stamp duty (which is zero on unsold homes in any case so of academic interest) will be recovered by a far larger amount of GST proceeds.

As demand picks up across the board, factories manufacturing consumer goods (from TVs to furniture to automobiles) will reach capacity utilisation levels of over 85% (currently, on average, at 75%) and will draw up expansion plans - leading to more demand from the capital goods and materials sector which will need to provide those products - all creating more jobs.

India's capital investment to GDP has shrunk from >20% in the 2000-2010 period to about 15% the past few years.

With an injection of USD 100 billion, with a multiplier of anywhere between 4x to 6x, India will add USD 400 billion to USD 600 billion to GDP.

Remember the numbers at the start?

This adds up to about a 20% addition to GDP. Spread it over 3 years if you wish and that is about 7% per annum.

Our 5% rate of growth in GDP can hit 12%.

And because of this initial spurt from clearing existing unsold stock, the follow-through from companies adding to capacity and creating jobs (and incomes) will add a 2nd stage rocket booster to the economic recovery. That 2nd stage capex addition will additionally lead to more capex and more job creation in the capital goods and materials sector.

There will be a price to pay: Inflation.

With GDP at over 10% in real terms, inflation may crawl up towards an uncomfortable level of 7% to 8% - this will be a repeat of where we were in 2005, 2006, 2007.

But it is not a cause for alarm.

The trouble in 2005-2007 was that demand within India was still from a narrow base. Over the past decade, incomes have grown and the Indian economy has widened in terms of participation. Plus a lot of the inflation at that time was imported due to high global energy prices. Oil is 60% cheaper than it was in 2005-2007. The world was booming in 2005-2007. Today the world is ill and tottering with few economies showing any spark of life.

If Prime Minister Modi's economic team wants to surprise the PM with a path to a USD 5 trillion economy by 2024 - adjusted for a knock from COVID - there is a simple 3-step process:

1. Get developers to drop home prices
2. Reduce transaction costs
3. Reach out for the USD 100 bn from pension and Sovereign Wealth Funds.

There is little need to wait for a budget to make such a policy announcement. A budget is an annual statement of accounts which previous Finance Ministers have chosen to steal for themselves in a race for TV ratings and popularity.

An 8 pm telecast by the Prime Minister always sets hearts beating and he should use it - as he has in the past - for path-breaking policy announcements.

May the Force be known to him!

(Article written by Ajit Dayal and carried by Equitymaster on 28 December 2020)