On 8 November 2016, Prime Minister Narendra Modi made an announcement declaring that notes of Rs 500 and Rs 1,000 would not be legal tender as a part of his government’s policy to clamp down on counterfeiting and black money. It has been widely reported that this policy would directly impact the real-estate sector, which typically witnesses a significant amount of transactions that are made through cash to avoid taxes. The Economic Times also reported that demonetisation would lead to a reduction of interest rates on housing loans, and consequently, to an increase in investment in the sector in the long-run.
R Nagaraj, an economist and currently a professor at the Indira Gandhi Institute of Development Research in Mumbai, is sceptical about long-term effects of the policy on the sector and its effect on interest rates. Nagaraj is a macroeconomic analyst who has studied the impact of black money on real estate. He has also been a guest professor at the Indian Institute of Management Calcutta and the Woodrow Wilson School at Princeton University. On 6 December, Kedar Nagarajan, a web reporter at The Caravan, spoke to Nagaraj—over email and a conversation on the phone—about the impact that demonetisation would have on the real-estate and housing industry.
Kedar Nagarajan: What short-term and long-term impacts will demonetisation have on the real-estate and housing sector?
R Nagaraj: As is widely accepted, black money plays a major role in real estate. In metropolitan areas, the ratio of black money to white money payment for residential housing is said to be 30-70. In smaller cities, the proportion of black money is said to be more. If a buyer wants to pay entirely in white money—by cheque payment—then the asset value gets revised up by 10–15 percent—a measure of the premium on black money.
Large and reputed builders have built a structure of multilayered legal contracts to protect themselves, and their brands, from the taint of black money. Probably, smaller and less credible builders—who operate more on contacts than on legal contracts—would deal with black money more directly and hence are likely to get affected by demonetisation.
Demand for real estate is down as the economy has not performed well during the last few years, if the deceleration in credit growth is any indicator, notwithstanding the official GDP [gross domestic product] numbers. If the foregoing reasoning is correct, then demonetisation would accentuate the demand constraint in the next six to nine months. Moreover, there is regulatory uncertainty, which would make a builder “wait and watch” before committing more money into the business. In the long-run, supply would depend on how the industry gets reorganised, that is, [the industry] reconfigures the ways to deal with the black money payment problem.
KN: Do you believe that black transactions in this sector will be curbed, in the long-run?
RN: Probably not. As any economist would tell you, black money is a flow, not—majorly—a stock, as it is popularly viewed. Black and white transactions are not like parallel tracks, but are closely intertwined like a parasitic creeper embedded on a large tree. The flow of black money will continue as long as the system—that is various laws and regulations—continues to generate black money.
KN: How will demonetisation’s impact on real estate differ in smaller towns and cities from larger cities?
RN: Real estate in smaller places is dominated by local, small-time builders, whose transactions are more likely to be in cash. Moreover, in small places, individual households often build homes by supplying the materials to a contractor [themselves, instead of paying the contractor to procure them]. Such transactions with local building materials suppliers tend to be on a cash-on-delivery basis. Such constructions are likely to be affected in the short-run. As the supply of cash improves, demand for such constructions may get revived, without affecting the generation of black money.
KN: It has been reported that this policy is likely to increase bank liquidity and reduce the interest on housing loans in this sector.
RN: I think there is a fallacy here. India’s balance of payment deficit [the net amount by which the sum of a country’s expenditure of funds exceeds the sum of funds received by the country], is at the margin, [and] is being financed by foreign-capital inflows, which are attracted to India because of the high returns they earn, relative to other economies. This fact limits how much lower the interest rates can go. India has to keep foreign investors happy to keep them invested here.
I do not think interest rates can come down drastically. Moreover, a bulk of the workers and households in the unorganised sector, without a stable and secure source of income, are outside the purview of housing-finance loans. So, to expect that the demonetisation will lead to a sharp fall in interest rates, and hence access to finance will increase to include the poor, seems far-fetched.
KN: The Economic Times reported that the government is considering initiating a new scheme, using the returns received from demonetisation to decrease interest rates for loans to first-time home buyers. Will this scheme be possible because of demonetisation, and will it genuinely lead to a greater number of people gaining access to permanent housing?
RN: I doubt it, for the reasons mentioned [above]. Assuming that this happens, then it is likely that a major share of it will accrue to richer households that will manage to grab the loans it in the names of their family members, and have greater credit worthiness in the eyes of bankers.
KN: An international credit-rating agency, Fitch, reportedly said that the drop in residential property prices would be more pronounced on high-end, premium property rather than entry-level housing targeted by first-time buyers.
RN: Yes, luxury housing prices are likely to get reduced more as they, I guess, have larger profit margin built into them. Even the so-called “entry-level” housing, to get the facts right, is not meant for the poor in India by any stretch of imagination.
KN: How has this policy impacted people in the informal sector whose livelihood is dependent on cash transactions in the real-estate sector?
RN: In the short-run, the demonetisation is, in fact, an assault on the poor, not just those employed in construction industry, [but also those] who are entirely dependent on cash for their subsistence, [and those] who have no credit worthiness to get credit from anywhere. If anything, the poor have become more vulnerable in bargaining with their employer.
KN: How will this policy affect ongoing projects?
RN: In two ways: one, lack of cash slows down construction activity in the short-run. Two, since payment in black money attracts attention from law-enforcement agencies, demand for real estate is likely to be affected until the uncertainties are sorted out.
KN: It has been reported that projects that were being stalled will now pick up speed.
RN: I have my doubts. The real-estate industry, as I said earlier, has been suffering from a lack of demand for the last few years. Demonetisation is like salt on the injury. I do not see any prospect of a demand revival unless there is a major public investment initiative to revive economic growth.
This interview has been edited and condensed.