Why the U.S. Credit Crunch Will Not Affect India

I’ve received numerous questions from colleagues and associates asking for my opinion on the U.S. credit crunch and its potential impact on the India economy and specifically the India real estate market. While complicated the short answer is no*, the impact should be minimal. You may have noticed that I added an asterisk and I’ll explain further below. First, we’ll quickly explore how the U.S. and Europe have been impacted, then discuss why Asia has minimal exposure, and finally I’ll explain the potential risks regarding my analysis.

The U.S. is undergoing a massive credit crunch due to the losses by large U.S. and European investment banks in the collateralized debt obligation markets (CDOs). The credit crunch is a result of banks and other financial institutions’ reluctance to buy CDO’s which in turn reduces the credit and loans extended by traditional mortgage lenders. At the same time, the exposure of banks to such non-performing obligations has reduced the willingness of other banks to lend to them and for banks to lend to developers. That in turn has caused property prices to go down (if you can’t get a loan then housing supply increases causing prices to go down) which gives consumers less money to spend which is causing a slow down in the economy. How’s that for a quick snapshot?

Since Indian banks have had almost no exposure to the U.S. CDO markets the loss potential from the U.S. credit crunch is minimal prima facie. However, some argue that the slowdown in the U.S. economy will reduce the amount of capital inflows to India thus hurting the India economy. This theory has largely been debunked by the European Central Bank report, "The transmission of U.S. cyclical developments to the rest of the world", which concluded that a one percent drop in U.S. domestic growth translated to a 0.1-0.5 percent drop in Asian GDP rates. Thus even a 2% drop in U.S. domestic growth will only slightly affect the projected 8% India growth rate.

The dollar rupee exchange rate is a concern as the rupee continues to appreciate versus the dollar however the effect is not pronounced enough to yet change the U.S. and European corporation from moving more jobs to India. In fact, at A.T. Kearney, I witnessed first hand how a slow down in the U.S. economy in 2001 forced the Fortune 1000 to examine cost reduction strategies with business process outsourcing [BPO] at the top of list. A.T. Kearney published a paper and survey with India as the leading country for BPO and the F1000 rush to India was on and has not let up. Thus I believe the further the U.S. slides into a recession the more business India will receive due to the cost savings. According to Mint (Wall Street Journal India), there is evidence of this phenomenon occurring today.

In a recent study conducted by the US India Business Council [USIBC] and Ernst and Young entitled 2008 USIBC Business Perception Survey, their overwhelming assessment of India is, and will continue to be, a premier destination for investment. Ernst and Young polled senior member-company executives to gauge their perception of India as a destination for investment and to identify progressive steps which will further enhance investor interest and confidence in India. Thus, the survey concludes, India will be an island of robust investment activity despite the global slow down.

India’s real estate sector is expected to reach $90 billion by the year 2015 from $14.8 billion in 2007. The increased real estate costs and a shortage of qualified IT talent in Tier I and II cities are forcing IT/ITES companies to locate offices in Tier III cities like Mysore, Jaipur, Chandigarh, and Nagpur.

India’s phenomenal growth in the real estate sector has lead to a bubble of speculative activity which has given early investors inflated returns. Those high profits have generated intense global interest with nearly all of the large foreign investment banks announcing new real estate funds or investments in current real estate funds. These funds along with local India investors have pushed real estate valuations to new heights. For example, when we first started in 2004, we passed on land being offered to us close to the new Bangalore airport. Now that same land has gone up by a factor of 10. However, it now appears supply is outpacing demand and the air in the bubble is starting to let out.

Some point to the slow down in the India real estate market as proof the U.S. credit crunch is currently affecting India. It is simply coincidence that the two are happening simultaneously. Moreover, the India real estate slow down is not uniform. There are areas in India where the commercial real estate market continues to appreciate (e.g. Gurgaon, Salt Lake V, Kolkata, and Bangalore CBD) because of high demand. The main reason for the current slow down in India is due to over-supply caused by developers building too fast to fill a limited supply situation. The current real estate slow down in India is simply a cyclical correction and should continue its upward cycle by early 2009.

Foreign investors, wealthy Indians and NRIs (see Table I) are still acquiring property around the country at an astonishing pace, making the real estate market among the most lucrative in the world yielding average returns of 25% annually, and according to some as high as 50%-60%. India’s real estate liberalization in the form of relaxed lending provisions (Bank loans for commercial real estate have grown 500% to $2.4 billion during the past four years) has also helped fuel the real estate market. Finally, we have seen building construction laws (such as the height of buildings and increased floor area ratios [FAR]) have been increased as well, instantly creating a more valuable project.

* Estimated – Table Source AssoCham

The all important asterisk and caveats to my analysis each in isolation should not greatly impact the India growth story. However, if some or all occur, then India may fall victim to a new set of concerns. For instance, increasing oil prices could lead to a slow down in the India economy due to India’s reliance on foreign oil. India bank losses in Asia that cause India banks to tighten their credit could impact the real estate developer who needs a construction loan. India foreign exchange fluctuations that make it more expensive for U.S. and European countries to outsource to India will have an impact on BPO services provided by India companies. Escalating food costs can quickly increase inflation thus hurting India’s economy. Lastly, a negative global perception could impact India’s real estate growth story despite India’s strong fundamentals.

In summary, India’s growth prospects are strong. There is no direct relationship to the U.S. credit crisis and the current real estate slow down is cyclical and geographically uneven. A subprime crisis in India is near impossible since only 3-5% of all home purchases have been completed with mortgages and within those, there are no sub-prime mortgages. U.S. and European companies will continue to outsource to India (especially in a recession) and India will begin to produce its own intellectual property (I’ll discuss this in part II) which will start an era of self reliance. There are many risks for India to guard against, but in isolation those risks will be mitigated by the India growth story.

Disclosure: Author is actively invested in India

Comments

[deepblue]

Hi

While macro numbers look very interesting, the fundamental questio remains which is buying ability of users. Given the rate of increase majority of asset will move out of reach for majority of indians as with all those glowing nos, India is still a country where almost 50% of population lives below poverty line ( less than a USd per day). As an investor myself, I think that in real estate P/E of majority hosuing locations has crossed the threshold now and later or sooner we are bound to see some reaction.

[cyberindian]

An interesting analysis above especially when the Indian government is pegging the growth at 8% for the year. There are talks of it getting into double digits at some time.
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The dependence of India on the world has significantly increased since the last time the ASEAN crisis shook the south-east asia, but has little or no Impact on India.

Having said that, the production and consumption fuel is available internally to take in a lot of the hit that might arise of the crisis caused by the US credit crunch. No - I'm not stating that India will be immune to this. there will be effects of the same, and the growth could well drop by a percent - percent and a half to around 6 - 6.5%.

What you are seeing in the Sensex is what the credit crunch is all about. with Foriegn investors pulling money out of the markets for the short term, there might be those trends of the sensex falling and catching up. Having said that, very few economies globally can offer a growth of more than 5% on investment overall, and hence India will continue attracting investments.

Current inflation in India is around 7% which can be dangerous. with Oil prices around the peak, the government subsidy on oil close to 50% will come under pressure, further leading to rise in inflation and a probable weaking on the ruppee.

Weakening of the Ruppee will make the Exports more competitive, but capex spends for internal growth from foreign sources will suffer. India is used to that situation for a very long time, so that would not be as alarming.

Overall, most combinations lead to a growth of close to 6% on the pessimistic side

[Mister C]

I would be wary of the intentions of the USIBC's poll.

We've heard the same rhetoric from the National Assoc of Realtors every month for the last 2 years.

Yeah. Housing is just fine. The sky's not falling over our heads.

Listen to them at your own risk and peril.

[dkp]

More serious than the US credit crunch is the coming elections and the attendant political meddling in the economy.

[Mister C]

I see you are part of a USIBC outfit! No wonder you say India will be just fine.

Talk of buttering your own bread and eating it.

[deepblue]

"Foreign investors, wealthy Indians and NRIs (see Table I) are still acquiring property around the country at an astonishing pace, making the real estate market among the most lucrative in the world yielding average returns of 25% annually, and according to some as high as 50%-60%. India’s real estate liberalization in the form of relaxed lending provisions (Bank loans for commercial real estate have grown 500% to $2.4 billion during the past four years) has also helped fuel the real estate market. Finally, we have seen building construction laws (such as the height of buildings and increased floor area ratios [FAR]) have been increased as well, instantly creating a more valuable project. "

All the above statements are misleading and am surprised how Seeking Alpha has allowed publication of such a misleading article with vested interest on its reputed platform.

Myth 1 : Banks are having relaxed lending norms.
Reality : Banks are no longer funding real estate and for last 2 years there is almost a ban on debt as well as ECB ( external commercal borrowings)

Myth 2 : Returns are as high as 50%. Returns were high and "are" not high. In fact majority of markets are seeing corrections. Further in any market, where assets are growing at 50% cost ( return of 50%), it will be soon be out from the reach of majority of people as Indian GDP is growing at 8% and not 50%,

Myth 3 : FAR / FSI has been revised upwards. I dont know of any area where FSI has been revised ( i am not sure of Mumbai) but no change in Karnatka, Delhi, Gurgaon etc.

In fact as of today the deals which are happening are highly over valued and majority of foreign PE players are going to end up with losses on thier face if they invest any further.

Check this article which was published in 2005 and has now turned to be correct

Bubble Trouble?
Your Home Has a P/E Ratio Too

by Prof Edward E. Leamer,
Director, UCLA Anderson Forecast

www.coolavenues.com/kn...

[Vijayashankar]

You have a very good point here. Always IT industry is having the link which gives the direct ups and downs in sync with USA markets. The FII investments are at 8%, so if bulk of them are from USA, then there would be some sync in ups and downs. If you see, only few banks of India, with foreign base got affected by the sub prime crisis. sont they say No risk (pain), no gain!

[suril desai]

The Finance Minister in March did announce a so called farm loan relief package of Rs 60,000 crore approximately US $ 15billion. Though the news papers and media reported it as a waiver for farmers, the amount was also used to "clean up" their balance sheets for loans given to retail and corporates as well.
To say that the Indian banks did not have exposure to CDO's would in a sense be misleading. Its just that the banks in India due to political backlash have refused to report it as losses related to subprime.
I find it hard to believe that in near absence of rural banking, the Indian farmers could borrow to the extent of $15billion. It does not make logical sense and why would the government couple it with losses to loans given in retail and corporate??? what percent of the national write off was for farmers could be anyones guess.

[ivebeentold]

DEEPBLUE: Chennai's FAR's have been significantly increased to accomodate housing needs of the poor.

Also, banks are no longer funding loans? a Ban on loans? That's crazy talk. They may have recently reduced the LTV for loans, but that's where Mezzanine financing comes in to fill the gap.

Deepblue you need to do your research.

[Excelsior]

"Foreign investors, wealthy Indians and NRIs (see Table I) are still acquiring property around the country at an astonishing pace,"

This is mileading and false as foreigners are not allowed to buy property in India (the ones who have managed to buy now can't sell). It is a complete bureaucratic mess with treacherous traps laid everywhere for the property to be confiscated.
British expats are being stung right now in India.
See:
britishexpats.com/foru...

All these "a la" experts should do they homework before posting their articles.

[deepblue]

hi ihvbeentld

Tell me name of bank who has opened loan to Realty sector or builders. Everbody knows that how RBI has been chasing banks to curtail their rela estate exposure.

if chennai has seen increased FAR that does not mean whole India has seen that and anyway chennai is suffering from over supply.

Problem is the author belongs to a group which has substantial investment in indian real estate market and they have to build hype on india to sell their stuff.

[special1person]

India still has severe sanitation issues.

I saw a comedian a couple weeks ago describe her trip to India.

Said she saw a guy in a 3 piece business suit squat down and do a #2 right there in the middle of the street.

Is that where you want to buy real estate?

[Candoguy]

It's a comedian's job to exaggerate. If you let that affect your investment decision, who's the loser? Agree with your first line, though, but it still has no bearing on the R/E issue.

[Vinz]

Interesting points but it seems that the author does underestimate the weakening of the dollar & the job situation in the US.
The key questions that each US companies may ask themselves : It is worth to continue to outsource in India whilst your investments become more compelling in your own country (due to foreign currencies getting stronger)?

[DeepakShenoy]

I live in Navi Mumbai and travel a lot to Gurgaon and Bangalore, and keep tabs on real estate in both places (relatives and friends are investors here). Prices are coming down and supply is at phenomenal levels. Ghost buildings (complete but zero occupancy) are the norm here in Navi Mumbai and gurgaon and outer bangalore head that way. CBD in Bangalore is starting to crap out - deals are just not happening.

Even in Mumbai deals have fallen though, auctions have failed and prices are dropping fast despite builder cartels vowing to keep them stable.

Gurgaon and Dwarka have a massive oversupply coming up and you can see this happening as builders delay possession (lack of final payments because investors aren't finding buyers).

Real estate loans are comign down - growth slowed to 20% last quarter, and with a CRR hike, rates stay high, andloan offtake slows.

We have our own version of subprime - if people default here, banks have a long long foreclosure process, and recovery can take years.

It may not be US Subprime that affects India - it was never that, we had our own bubble - but the bust will typically take 5 years before growth starts again. Cycles in India have been 10 years long - the last highs were 1985-87, then 1994-96, and then 2005-07. I expect the bubble to have bust completely by 2011.

But it's a non transparent market, so we will only know much after the fact.

[EclecticInvestor]

This will be the final high, because, post this, we will see such a severe shock, that it could be that real estate in India will not rise again. eclectic-investor.blog...

[WickedPedia]

I was in India until recently and have made a common observation about the real estate prices in metropolitan cities and the other upcoming ones. The real estate prices seemed to have a strong connection with the spending power of the residents. For e.g. the cities such as Pune , Kolkata , Guragaon , Noida have seen a huge influx of IT/Tech workers in the last couple of years. Now, with the single , well paid , young workers looking to rent than own a house (in most case share to reduce the rent expenses) , the real estate developers have found a huge market to cater to by building not only residential but also commercial structures. To call it a real estate boom - I don't know for sure as most of these developments have been spurred by the increasing economic activity, increasing employment and spending power of the consumer. So the fundamentals still look strong. What it has led to in some cities is this 'follow the leader' mentality of real estate developers to develop large spaces of land without assessing the market - which of course led to some markets crashing and leaving behind those ghost buildings (as discussed earlier). Now, Bangalore is a different beast altogether and I would not move there even at a gun point. I guess Bangalore went bust because of "excess" (sub prime lending, excess building - see a common thread here). So while the real estate builders were going crazy in Bangalore, some of the major domestic and international firms were looking at other smaller, cheaper cities for setting up their shops.

So the take away - excess kills the access!

That's all folks!