A data point that hasn’t got a great deal of coverage internationally is that of the decade-long gravity defying rise of the Indian real estate sector. To put it into perspective Indian real estate prices have increased by 5x–6x in most regions, and the speed of the price rise in India outstrips that of economies that had a housing bubble (such as Spain, Ireland and the US). This realty boom has all the makings of what could be a spectacular collapse… but the trouble is that most people are unwilling to see it.
I first started warning of a housing bubble in India about a year back – in December 2011. That was when I had finished work on my book, Spot the Next Economic Bubble, which utilized the Austrian Business Cycle Theory (ABCT) as the cornerstone for
analysis. There were next to no takers for my advice then. There are also very few takers today.
So does a real estate bubble really exist in India? And do my warnings about the impending disaster hold any water? Before examining this point in more detail, let’s first recap what the ABCT tells us about bubbles.
What is a Bubble?
The biggest advantage that the Austrian view offers is that it enables us to clearly define a bubble. According to Austrian economists, a bubble is a term used to define an activity that has sprung up on the back of loose monetary policies. The main factor behind bubbles is the fuel for speculation – which is low real interest rates. The fuel for speculation comes when the Central Bank
expands credit by creating “mickey mouse” money out of thin air. “Mickey mouse” money has to go somewhere… and it fuels a speculative bubble where it does.
Given that money is non-neutral, the early recipients of new money (or the first movers) always have an advantage since they are able to out-bit late recipients for goods and services. Additionally, these monetary injections act like a steroid given it turbo-charges activity in interest rate–sensitive sectors such as housing construction. Moreover, easy access to credit (enabled in part by monetary injections) also have a role to play in inflating bubbles, given that with the aid of leverages asset prices can be inflated beyond the wildest imagination. Therefore if you want to spot a bubble, you must first examine if asset prices are rising on account of increases in the money supply (and thus credit) or on account of genuine savings.
With this background let’s have a look at the conclusive evidence that suggests the existence of an Indian housing bubble. Towards this I reproduce the analysis I have included in my book Spot the Next Economic Bubble (in Chapter 9) in the following section.
Bubble Spotting in the Indian Real Estate Sector
A 5x–6x increase in housing prices in under a dozen years is nothing short of spectacular when compared to other cities across the world. What is more astounding is that the actual price rise in Indian cities is likely to be higher than the reported figures suggest given that it is widely acknowledged that the official housing prices are under-reported for computation of tax gains - and this is something that the government is attempting to remediate by reforming the stamp duty transactions in states.
What is actually driving the entire real estate party in India is the ever-increasing monetary injections into the economy by the RBI. Money created out of thin air is like a steroid which turbo-charges what is going on within an economy. Additionally, credit is like heroin where a little is never enough and more and more is needed to sustain the artificial high. Without monetary inflation, prices wouldn’t (or couldn’t) have increased at this pace. There is only one way to test if this theory does hold any water.
From the point of view of Austrian theories, the only thing in the world that preserves its value in the face of monetary infusion is gold [Check Note 2]. Towards this, let us attempt to adjust property prices with gold prices as the base (see below).
The evidence available almost irrefutably points towards the fact that India is in a speculative bubble. While data does suggest and point towards a real estate boom in cities of New Delhi, Mumbai, Bhopal and Kolkata – the outlier Bangalore has had modest price increases during this period. But Bangalore did not miss the Indian real estate boom. Bangalore did have a real estate boom – but a boom of a different nature i.e. where supply increased enormously and consequently real estate prices didn’t.
Deconstructing Argulements against a Bubble
Ostrich Argument #1: Cannot happen in India. We have a densely populated country with scarcity of land and growing demands for housing. While both these arguments appear to be logical, this fails to take into account historical evidence. The most spectacular real estate collapse in history occurred in Japan… and the scarcity and population density arguments were the same.
Ostrich Argument #2: India’s fundamentals are intact – and we needn’t fear a bust. Unfortunately this is also an argument that doesn’t seem to be grounded in reality. Closer examination of the ‘fundamentals’ of the Indian economy show Austrian boom patterns and paint a worrisome picture, specifically:
- Faltering GDP growth rate (expected to be sub-5% in 2012 fiscal – the lowest in a decade)
- High budget deficits. Increasing public debt. These would get worse in future owing to welfare (such as Direct Benefit Transfer based on the Aadhar card) and public works schemes (such as MGNREGA).
- Slowdown in industrial production as reflected by IIP data. Weak corporate performance by heavy industries in recent quarters.
- Chronic inflation and depreciating currency.
- An increasing trade deficit.
- Falling domestic savings rate (in single digits – the lowest in a decade).
- Increase of NPA’s on the balance sheets of domestic banks.
Ostrich Argument #3: A definite rise in prosperity as illustrated by sales of luxury cars and designer labels; swanky restaurants and malls. However consumption can never be taken as a sign of sustainable economic growth. A prosperous and growing economy is one that produces more goods, and not one which consumes more. Unfortunately these examples are more reflective of conspicuous consumption which manifests itself during a false boom. Monetary inflation tends to drive money into assets increasing the net worth of the super-rich, ultimately manifesting itself in the form of conspicuous consumption. Additionally, inflated asset prices makes people think they are richer than they really are, and the seemingly surplus funds are likely to get splurged on account of this money illusion. This too is consistent with ABCT.
Ostrich Argument #4: Lending standards of banks and financial services institutions are not lax. There may be an element of truth in this statement. Specifically the Reserve Bank of India (RBI) has imposed a Loan to Value Ratio of 80%, stepped in increased risk weights on housing loans, and increased standard asset provisions on teaser loans. However government regulations have never been able to prevent bubbles from occurring in the past (the case in point being the collapses of companies such as Enron and the US financial houses in 2008 – all of which operated in heavily regulated environments). Irrespective of the regulations in place, funds created by credit expansion out of thin air need to go somewhere, and given money is non-neutral
it would fuel a speculative bubble in the process. Moreover, what goes un-noticed is that the realty boom has also in part been driven by the growing services sector in India – comprising of financial services, outsourcing, and media – all of which would come under heavy weather in the near future on account of global cues arising of the weakening of Western economies.
Ostrich Argument #5: Prices may fall – but not too much. This is the final argument offered when all other arguments are broken down. But the reality appears to be that people have short memories. Real estate that appeared to be over-priced in 2008 appears to be reasonable today given the constant monetary inflation which has fueled price rise. Unfortunately ABCT is also fairly categorical about what the eventual bust would bring with it. Following the end of an artificial boom asset prices are likely to return to pre-boom levels, or even below that. Price adjustment can be delayed through intervention in the form of stimulus, bail-outs, and through more monetary injections…. but cannot ever be prevented. A case in point is Japan which has seen ten rounds of monetary stimuli since their real estate bubble popped; but property prices are still way off the 1980 levels. Also, the attempts of preventing liquidation of poor investments through fiscal and monetary stimulus in the US following the 2008 crisis are less than convincing.
Ultimately one cannot think of any good arguments to refute the case against a bubble. It becomes more obvious if you were to analyze rental yields on housing. In India gross rental yields are around 2.68% in most metropolitan cities which are amongst the lowest in Asia [Check Note 3]. Asset prices disconnected with yields is the most evident tell-tale sign of a bubble.
Don't Tell Me How... Tell Me When!
Given the decline of economic activity, the RBI has attempted to gradually inflate using Open Market Operations (OMO). However this gradual expansion of M3 in H2 2012 is likely to be insufficient to prevent bubbles from collapsing.
For those who have real estate investments in India, it might be advisable to stop dancing before the music comes to a sudden stop. And do remember that there is adequate historical proof that real estate prices can also fall – and it is unlikely that India will be a special case.
[2.] Carl Menger viewed money as an economic good just like any other good. But Menger considered money to be the most marketable economic good. Menger believed that money originated spontaneously as a result of market processes to overcome
the limitations of the barter system, and ultimately it is the market that defines and chooses what would be acceptable in money. Markets have traditionally considered gold to be a marketable economic good and hence has been used as a store of value. Thus, Austrians do not consider gold to be a worthless yellow commodity. Instead gold is considered to be money.
[3.] Source http://www.globalpropertyguide.com/Asia/rent-yields as retrieved 28 December, 2012.
[4.] Source: Info graphic from http://economictimes.indiatimes.com/markets/real-estate/realty-trends/buying-a-home-to-get-cheaper-as-rbi-says-no-to-restructuring-of-real-estate-loans/articleshow/17406901.cms