Thursday, June 17, 2004

india's quiet revolution

The growing popularity of mortgage financing in India will do more than just enable millions to become first-time homeowners. It will deepen the financial market, boost the housing and construction industries and spur economic growth

By Shailaja Neelakantan
(This article appeared in the Far Eastern Economic Review in June 2004 ).

SURESH VARMA, a 32-year-old entrepreneur who runs a small advertising company, recently splurged on a 3.5 million rupee ($77,000) home in the upmarket New Delhi suburb of Gurgaon, for which he took a home loan of 2.5 million rupees. Varma began his career living in a two-room house and driving a beaten-up scooter. Now, he owns a (financed) fancy Honda City car and a plush three-bedroom apartment. His father, who is a retired central-government employee, isn't too happy at the amount of debt his son has taken on. "What if his business goes through an extended downturn?" he wonders.

Sunila Awasthi, a 35-year-old New Delhi lawyer who earns a little over 100,000 rupees a month, had always dreamed of a top-of-the-line car. So, recently, she decided to buy a 1.5 million rupee Honda CRV, a model just introduced in India, becoming probably one of the first owners of the luxury sport utility vehicle in the city. To buy the car she borrowed approximately 800,000 rupees from a bank, something her mother's generation would never have dreamed of doing. Credit was considered evil and creditors devils incarnate.

But times and attitudes have changed. Varma, Awasthi and millions of others of the same age group or younger, don't believe in waiting for tomorrow to buy a house or a car or expensive home-entertainment system. Unlike their parents they don't believe in saving up for decades. They want the good life now--and that desire is driving a revolution in consumer finance that will help millions of Indians become homeowners.

"The traditional value system involved saving for the future and for one's children," says K. Cherian Varghese, chairman and managing director, of the Corporation Bank. "But there is a shift in the thinking of the middle class. They want a better quality of life today and things like a scooter and a refrigerator, which were once considered luxuries, are now considered necessities. Also, more and more people are graduating from the low-income group to the middle class," he adds.


Following India's economic liberalization since the early 1990s, consumers not only have a mind-boggling array of goods and services to choose from, but also the means to acquire them. And housing finance is probably the fastest-growing segment in consumer lending. "Borrowing today in India is a means of achieving independence and success and borrowing for a home is looked at very positively," says Rajan Sastri, research head at Indiaproperties, a property-listing-services company.

Ten-or-so years ago, housing and other personal loans carried interest rates of 19%-21%, but now housing loans come as low as 7%. And with the government offering tax rebates on the principal and interest, the effective rate for the customer can be as low as 5%-6%. While rates aren't expected to fall further--in fact they are expected to rise in the near term, especially in the context of rising oil prices--the housing-finance sector will continue to flourish because there is still surplus liquidity in the market and the tax rebates will stay in place, at least until the next budget.

It is no wonder that the housing-finance market has grown by leaps and bounds. It is estimated that housing loans worth between 450 billion rupees and 500 billion rupees were approved in fiscal 2003-04. Last year, approvals for home loans rose 42% on the back of a 40% increase the year before, says Sandesh Savant, a Pune-based property consultant. Savant expects the same if not higher growth this year, even if rates rise.

With interest rates for fixed deposits and savings accounts declining in the past decade--they are currently at almost at a 30-year low--there is no advantage to saving or paying rent. Property is also cheaper now compared to 10 years ago. "Back then, a house would cost 10-15 times someone's annual income. Today it is only about five times a person's annual income. For five years until 2003, property prices on average have come down 20%-40%," says V.S. Rangan, general manager, corporate planning and finance, at HDFC, India's largest home-loans company.

One reason for the drop in property prices is that many states in India have repealed the Urban Land Ceiling Act, which limited the amount of land people could sell or develop. They had to get permission from the government to do so, and the government had the right to acquire any land in excess of the ceiling and could compel the owner to use it for purposes it specified.

In addition, 10 years ago, it would have been extremely difficult to get large loans of the kind Varma and Awasthi have taken. It was not easy to get a mortgage as a bank would not lend based on a lien on the property, but on the borrower's financial status and whether he could get a co-signatory, or a guarantor, for the loan. "Banks would come and interview you before you got anywhere close to even making an application. And foreclosing a property was not easy. That has changed in the past three years. Now the Indian government has enacted certain foreclosure laws which make it easier for banks to foreclose," says Sastri of Indiaproperties.

Mortgages constitute just 2% of India's GDP compared to 20% in some other Asian countries and 51% in the United States, according to ENAM, an equity-research agency. So India's market has enormous potential to grow. After all, less than 20% per cent of Indians currently own their own homes. If present trends continue, analysts believe the number of urban, middle-class Indians who own homes could triple in a decade.

"Provided economic activity continues to grow, we have targeted the home-loan segment to be in excess of 650 billion rupees by next year," says Sastri, even though banks today only provide mortgages for a home to a home buyer. Banks are reluctant to lend to property developers, largely because their projects aren't very transparent and often involve black money, he says. Thus large land developments are still privately funded, and as a result, building large rental condominiums is nearly impossible. "Once banks start funding mortgages to investors, we shall see yet another segment of the mortgage business opening up," he adds.


As it is, the lending market, especially for homes and vehicles, has become extremely competitive. HDFC is the leader in the housing-finance segment but snapping at its heels is ICICI bank, which is known for its aggression and wide reach. In fact, it is probably the biggest player in the vehicle-loans segment. "We started four years ago and today we have about 40% of the car and two-wheeler loans market and about 22% of the commercial-vehicle loans market," says Sachin Khandelwal, head of vehicle financing at ICICI Bank.

With interest rates at an all-time low, a spurt in lending volumes could lead to shrinking margins, but this doesn't seem to be a concern for housing financiers and banks. "Margins may shrink but look how much volumes are rising. Besides, margins are a function not just of interest rates but also of operating costs, which are declining as volumes increase," says Rajiv Sabharwal, chief operating officer at ICICI Home Finance.

Housing financiers, banks and analysts believe that the government needs to do more to stimulate the sector, as ENAM and the National Building Organization estimate that there is a demand-supply gap of 20 million homes. They believe that stamp duties, which are currently at a high 8%-14% of transaction value, should be reduced to 3%-5%. "The cost for first-time buyers should be lower and people should also be able to graduate to bigger houses without having to pay such massive stamp duties each time," says ICICI's Sabharwal. He adds that foreign direct investment inflows should also be encouraged to develop the property sector. Currently, a foreign developer is only allowed to operate in the country if the company has a minimum of 40 hectares of land at its disposal.

Nevertheless, several foreign companies have already jumped in. Westport of Malaysia has a 10% stake at an undisclosed premium in the New Delhi-based Feedback Ventures Group. Kontur Bintang, another Malaysian company, along with G. Gnanalingam, a Malaysian citizen, have agreed to contribute $1 million each towards the share capital of a Gurgaon residential township. Singapore-based Ascendas has a joint-venture agreement with Tamil Nadu Industrial Development Corp. for developing information-technology parks in Chennai. Indonesia-based Universal Success Enterprise and Unitech, a New Delhi-based real-estate and construction company, are involved in a joint venture to promote an information-technology park and housing project near Calcutta.

"India will have to go through a legal revolution in order to able to scale up its opportunities and its ambition to provide housing for all," concludes Sastri of Indiaproperties. "All reforms that make housing more affordable will definitely increase home ownership."