A newsletter that demystifies
complex economic jargon and
explains how it impacts your
By Vivek Kaul
Here’s a great value proposition
A digital subscription to Mint can be yours with a flat 25% off (Up to 40% with bank offers), at just ₹160 per month. But hurry, the offer is valid till 19th April. Check out the convenient and affordable plans we have for you here.
Dear reader, Easynomics will now hit your inbox every Wednesday instead of Friday.
First-order thinking is very easy. Much of popular economics is full of that. Nowhere is this clearer than in the hoarding of residential real estate that the Indian rich indulge in. In fact, this has led to problems in the affordable housing market. And it also adds to global warming. Dear reader, if that has shocked you, I am not just saying this to draw your attention (okay, who am I kidding, maybe I am!).
In an excellent recent piece on affordable housing in the Mint, Madhurima Nandy and Rituraj Baruah write: “The low-cost housing dream has cracked.” The real estate companies or builders are no longer interested in building homes for the affordable housing market.
Anyone who has followed the housing loans given out by banks over the years would know that this trend has been playing out already.
Take a look at the following chart. The chart plots the proportion of outstanding bank home loans given to the priority and non-priority sectors.
According to the Reserve Bank of India (RBI), a priority sector home loan is defined as: “Loans to individuals up to Rs 35 lakh in metropolitan centres (with a population of 10 lakh and above) and up to Rs 25 lakh in other centres for purchase/construction of a dwelling unit per family provided the overall cost of the dwelling unit in the metropolitan centre and at other centres does not exceed Rs 45 lakh and Rs 30 lakh, respectively.”
Hence, in cities with a population of 10 lakh or more, home loans of up to Rs 35 lakh for homes priced up to Rs 45 lakh get categorized as a priority sector home loan. In other centres, home loans of up to Rs 25 lakh for homes worth up to Rs 30 lakh get categorized as a priority sector home loan.
As can be seen from the above chart, the proportion of outstanding bank home loans to the priority sector has fallen dramatically over the last 15 years. What does this mean? Before we understand this, let’s look at a few more things.
Outstanding home loans at the end of a period are obtained by considering the outstanding home loans at the end of the last period, subtracting the loans repaid during the current period and then adding the fresh loans given during the current period.
Further, other than banks, home financiers also give out loans. A look at decadal data suggests that banks have given out around two-thirds of the outstanding home loans over the years. With home-financier HDFC set to merge with HDFC Bank, that ratio will move further in favour of banks.
Now, getting back to what we were discussing. Priority sector home loans have fallen dramatically over the years. Take a look at the following chart. It plots the priority sector home loans outstanding and the non-priority home loans outstanding at a given point in time.
In April 2015, the priority sector home loans and the non-priority sector home loans both stood at Rs 3.2 trillion. After that, the non-priority home loans kept growing, whereas the priority home loans took a beating. What does this mean? This means that banks have stopped financing affordable housing. And that has happened because homes are no longer selling at affordable levels.
In February 2020, the priority home loans peaked at Rs 5.2 trillion. Two years later, they stood at Rs 4.9 trillion. This primarily means that banks haven’t given out a single rupee of fresh priority home loans on a net basis during the last two years. So, banks aren’t financing many homes worth less than Rs 45 lakh in cities and less than Rs 30 lakh in other areas. No wonder the affordable housing dream has collapsed.
In the last five years, lending to the non-priority sector has grown at 17.3% per year, which means it has more than doubled. In March 2017, the total loans had stood at Rs 4.9 trillion. By February 2022, they had jumped to Rs 10.9 trillion. During the same period, the priority home loans have increased from Rs 3.6 trillion to Rs 4.9 trillion.
Why is this happening?
Many economists believe in the free market. In a free market, if the price of a product or a service is on the higher side, newer businesses enter looking at the opportunity to profit. Hence, the supply increases and the prices automatically drop, adjusting to the new reality.
This dynamic worked beautifully after covid broke out. People stocked up on masks, and prices went through the roof. Many entrepreneurs sensing an opportunity, entered the market, the supply went up, and the prices came down.
But this dynamic doesn’t apply to India’s residential real estate market, even though there are thousands of real estate companies all across the country. The free-market dynamic does not apply because most new entrepreneurs entering the real estate business are involved in politics or are fronts for politicians looking to diversify from their main line of work or simply looking to put their black money to some use.
This stems from the fact the business is so heavily regulated at the local level that anyone without reasonable political connections wouldn’t be able to get any project going.
This explains why many real estate companies are run by politicians or are fronts for them, or are run by large corporates who are in a position to manage the huge political risk that comes with the business. It also explains why there are almost no-pan India real estate companies, given the need for political management.
In this environment, the dynamic of a free market does not work. Even if there is an excess supply of residential homes, as has been the case for quite a few years, most builders are ready to wait it out. The conventional metrics of net profit and return on investment do not really bother them.
This leads to market stagnation, where there is a low demand for new homes from people looking at homes to live in, and at the same time, there is a low supply of homes as well. Even though enough homes are available, they don’t fall in the price range of those who want to buy homes to live in and thus there is low demand. With the supply not clearing, new projects also come up at a slow pace.
So, we have a weird situation of low demand and low supply. This is a scenario that theoretical economics, which believes that the invisible hand of the free market makes things right, doesn’t really take into account.
As David Orrell writes in Money, Magic and How to Dismantle a Financial Bomb: “For example, the law of supply and demand assumes a world where an infinite number of economic agents are in perfect competition with one another, as opposed to the real world where prices are usually set by the most powerful players.” Nowhere is this truer than the Indian residential real estate market.
The 25 March newsletter, How real estate speculators are leaving Indians homeless, had essentially dealt with how investors in real estate make things very difficult for those wanting to buy a home to live in. This was because they add to the demand for a home without really needing it, given that they are already living somewhere else. Of course, there is nothing that can really be done about this.
As Orrell puts it: “After all… who is to judge if this type of consumption is better or worse than other forms of spending.” At the same time, this investment is inherently unproductive given that “it acts as a brake on the economy by raising prices for workers, pricing new recruits out of the market, and diverting resources from more useful purposes.”
This point I have already discussed earlier. And that being the case, I wanted to make another point today, which is something that we all should be thinking about. It’s also a great example of why second- and third-order thinking on issues is very necessary.
In order to build anything new, including residential real estate, a lot of energy is needed. As Orrell writes: “Economic activity has also long been associated with energy consumption of the direct physical sort, usually from burning something, be it wood (the discovery of fire kick-started the caveman economy), whale oil, coal, natural gas or crude oil.”
How does this apply in the present context? Building a home needs a lot of things like steel, bricks, sand, concrete, ceramics, plastics etc. As Vaclav Smil writes in How the World Really Works: “Tall apartment buildings stand on concrete piles, concrete goes not only into foundations and basements but also into many walls and ceilings.” It takes a lot of fossil fuel energy to produce concrete, and steel, and plastics, and bricks and so on.
In the book, Smil refers to cement, steel and plastics as the three of the four pillars of human civilization (the fourth being ammonia). As he writes: “The mass-scale production of all of them depends heavily on the combustion of fossil fuels, and some of these fuels also supply feedstocks… for the production of plastics.”
Hence, the fact of the matter is that building new homes ends up using a lot of fossil fuel energy in an indirect form. And when this fossil fuel is burnt to produce the energy required to make the inputs that go into the building of a house, it adds to global warming, something the world at large has been struggling to deal with.
Hence, if a newly built home is bought by an investor and simply locked away, it comes with costs attached. Besides leading to wastage of financial capital, it also leads to the wastage of everything that has gone into the making of that house and that comes with environmental costs attached to it.
Bill Gates makes this point rather coherently in his book How to Avoid a Climate Disaster: “When I look at [a] new building…I see tons and tons of steel, cement, glass, and plastic… Making all these materials emits lots of greenhouse gases. In fact, they’re responsible for about a third of all emissions worldwide. And in some cases, notably concrete, we don’t have a practical way to make them without producing carbon [dioxide].”
Of course, this does not mean that we should stop making new homes, but if these homes are simply bought as a financial transaction and locked away, then there is a problem with that.
Hence, the government needs to discourage buying new homes as an investment in that sense. That will solve a part of the problem. But the real problem will be solved only when real estate investors can carry out some second- and third-order thinking themselves and realize that buying new homes and keeping them locked is a terrible thing to do.
The trouble is that how do you expect human beings to worry about something that they can’t even see. As Richard Thaler ad Cass Sunstein write in Nudge—The Final Edition: “Greenhouse gases are invisible in the air. If you can’t even see them, you might not worry about them.”
Also, who is the villain of the piece here? As Thaler and Sunstein write: “For some threats, there is an identifiable perpetrator—a wrongdoer whose terrible deeds capture public attention. It’s not so hard to mobilize public attention and spend resources to combat terrorists, especially if they are led by prominent people and determined to carry out terrorist attacks. Climate change is faceless. It is a product of the actions of countless people—effectively all of us, over a very long time.”
And that’s how, my dear readers, things stand now.
Let me end with something that Orrell says towards the end of his book, and that makes tremendous sense. As he writes: “If we shut down major parts of the economy, such as aviation, to flatten the infection curve for a virus, it surely makes sense to shrink parts of the economy that are highly energy-consuming, but also largely unproductive and parasitic, in order to flatten the curve for the climate.”
Unoccupied homes are “a very real claim on the planet’s resources”. This is a point that people who buy residential real estate as an investment and keep it locked need to understand. In that way, they are making things difficult for their children and grandchildren by making the world at large a less inhabitable place to live in. Nonetheless, as the old Doordarshan advertisement on wearing helmets went: “marzi hai aapki aakhir sar hai aapka (it’s your choice, after all, it’s your head).” Of course, it's not just you, but your kids, your grandkids, your greatgrand kids…
Were you forwarded this email? Did you stumble upon it online? Sign up here.
Written by Vivek Kaul. Edited by Saikat Chatterjee. Produced by Nirmalya Dutta. Send in your feedback to email@example.com.