Excerpt of Mr. Parikh’s Speech in CREDAI’S Meeting in 8th Dec 2000
It is indeed a pleasure to be here today to address a session on ‘Finance Resource Mobilisation – The New Initiatives’. This convention provides perhaps the best platform to take stock of the Indian Housing Finance System – where we currently stand, what changes we would like to see in future and more importantly, how these changes can be effectively implemented.
To start on a positive note, I was scanning through the final recommendations made at the last all India conference entitled “Housing : The Challenges and Solutions” held in November 1998. I was sufficiently pleased to notice that we have just about reached the half way mark-with the authorities having accepted and implemented about 50 per cent of our recommendations. This is indeed encouraging and though the challenges before us are manifold, it is good to note that conferences like these are helping us carve out solutions for a better tomorrow.
Overview of the Housing Sector
Universally, the housing sector is recognised as an engine of domestic growth and an anchor of social stability. In fact, macroeconomic stability or instability and the housing and real estate sector are inextricably linked. However, in contrast, while India’s GDP growth rate in the recent period ranks among the best in the emerging countries, the same unfortunately, cannot be said about its housing sector.
The importance of the housing sector in India can be judged by the estimate that for every rupee invested in the construction of houses, 78 paise is added to the gross domestic product of the country and the real estate sector is subservient to the development of a number of other industries. The real estate sector is also the second largest employment generator in the country.
Earlier, the tendency of the government had been to view housing finance from the angle of its cash budget and not as a developmental activity with tremendous spin-offs to the economy. But over the last two years, through the National Housing and Habitat Policy, the government has called for a ‘Housing Revolution’. The government has recognised the importance of housing in the economy and is committed to creating a facilitating environment for the growth of housing activity, rather than take upon itself, the task of construction.
India continues to face an acute shortage of housing units. The housing shortage was 22.9 million units in 1991 and estimated to reduce to 19.4 million units by 2001. A caveat, however, regarding housing statistics : key information that reflects the performance of housing markets such as housing starts, sales volumes, movement of house prices and defaults on mortgage loans are insufficient, incomplete and not updated regularly. And a point to note is that the housing shortage numbers available are based on the 1991 census, with no endeavour to update these statistics.
It must be recognised that the availability of timely and accurate housing statistics is extremely vital. In fact a lesson to be learnt from the economic debacle of South East Asia was that it was the lack of adequate housing information which failed to provide strong and early signals of the real estate market crashes.
Housing Finance Requirements
But quite clearly, the greatest challenge for the housing industry today is to ensure that sufficient resources are mobilised and channeled into the industry. According to the ninth Five Year Plan, an investment of Rs.1,51,000 crore is required for the housing industry and it has been estimated that not more than 25 per cent of this will flow from banks, financial institutions and the Central and State governments. This presents a rather grim picture, but this need not be the case.
Now just to look at the situation outside India. Today, although housing finance is available in most countries, in many, it is available only to a privileged minority. And this is particularly true in-lower income developing economies. But we must recognise that housing finance can be provided to a larger segment of the population, if the lenders and the government officials think creatively, provide new instruments and devise risk-sharing schemes.
As a housing finance system enters the secondary phase of development, securitisation is required to integrate the real estate market with the capital market. In India, we had been talking about a pilot securitisation project for over five years, And finally in August this year, the first mortgage-backed securitisation deal was closed and two more deals are lined up for early next year.
The pilot issue of mortgage-backed securities of the pool of housing loans originated by HDFC comprised class ‘A’ and class ‘B’ Pass Through Certificates (PTCs) , The class ‘A’ PTCs aggregated to rs.59.70 crore and were fully subscribed by Financial Institutions, Banks and Mutual Funds at the rate of 11.85% p.a. CRISIL has assigned “AAA(SO)” rating to the class a PTCs, indicating the highest degree of safety with regard to timely payment of principal and interest. The class ‘A’ PTC represents the during the tenure of class a PTC, every month, investors receive the principal component of the scheduled pool cash flows and interest on monthly rests.
The class B PTCs of Rs.28.61 crore were subscribed by the originator i.e. HDFC. Class B PTCs are subordinate to the class ‘A’ PTCs . Thus investors in class ‘B’ PTCs are entitled to receive the balance pool cash flows only after meeting the obligations on class ‘A’ PTCs. This was done essentially to enable investores to get a paper of a 7 year nature and also serve as a ‘Credit Enhancement Mechanism’.
A similar structured issue was also done with LIC Housing Finance for an amount of approximately Rs. 47 Crore.
Securitisation is a difficult instrument and lack of clarity on some legal and taxation issues, absence of foreclosure norms and high stamp duties were some of the impediments and reasons for the delay in introducing this instrument. Further, the dearth of market makers and the lack of awareness of such instruments make it a difficult and costly exercise to market.
Transfer of Receivable to be effective requires a written conveyance that attracts stamp duty. So far only four states –
Tamil Nadu have reduced the stamp duty to 0.1 percent for securitisation of housing loans. I strongly urge the government to take this issue up with the state governments to reduce the stamp duty on mortgage securisation paper. Rationalisation of stamp duties must be accorded top priority.
Further, to give the much needed boost to the development of the debt market and to increase the attractiveness and pricing on mortgage-backed securities, the Reserve Bank of India (RBI) should specify a lower risk weightage for securitised paper i.e. 50 per cent of the risk weight of direct housing loans. In addition, the risk weights on housing loans should reduce from the current 100 per cent to50 per cent, as is the international practice.
It has been increasingly recognised that the solution to the housing problem lies in the development of a comprehensive debt market for housing loans. The individual housing loan is normally a long-term investment ranging between 10 – 15 years, while the funds for the primary lender may not be for that long. The development of a secondary mortgage market ensures recycling of funds.
Mortgage-backed securities as a new financing instrument will benefit a number of entities. These include
Housing Finance Companies
Credit Rating Agencies
Institutional Investors and finally the
State Governments will also benefit with the pick-up in housing activities.
I do believe that we will be able to develop an active secondary mortgage market soon. This is because of the recent amendments to the National Housing Bank (NHB) act, which intends to provide a simple, speedy and cost effective method of recovery of dues from defaulting borrowers. Thus NHB has now been granted quasi-judicial powers.
The Central Government along with NHB will appoint “Recovery Officers”. If the borrower defaults, the HFC can apply to the Recovery Officer for the sale of the property-
assigned to the HFC as security. To facilitate the process of foreclosure, it is also proposed to establish a ‘ Housing Finance Institutions Debt Recovery Appellate Tribunal’. While guidelines are still being awaited for the implementation of the foreclosure norms, one hopes that a feasible solution can be put in place early.
But at this point I must reiterate that not once, in the past 22 years has the legal system come to our rescue at HDFC in helping us repossess even a single home. Foreclosure norms in isolation is not a panacea- if one looks at the track records of the Debt Recovery Tribunals, they are abysmal. A legal framework can only be effective if the cases can be resolved quickly.
But at this point I must reiterate that not once, in the past 22 years has the legal system come to our rescue at HDFC in helping us repossess even a single home. Foreclosure norms in isolation is not a panacea – if one looks at the track records of the Debt Recovery Tribunals, they are abysmal. A legal framework can only be effective if the cases can be resolved quickly.
But the upshot of the proposed NHB Act amendments are manifold – it is expected to pave way for the opening up of a Rs. 200 to 300 billion securitisation market, facilitate mortgage insurance, provide security to lenders, reduce NPAs, speed up loan recovery mechanisms and increase the pool of lendable funds, which currently are locked up in litigation.
Foreign Direct Investment (FDI)
One of the most plausible options to alleviate the acute cash shortage in the housing sector is to permit foreign direct investment (FDI). The government has clearly stated that it is committed to allowing FDI in ‘core’ sectors. But when it came to housing, the government has emphatically refused to allow FDI in this sector. Of course, granting infrastructure status to housing, but not acknowledging it as a core sector does appear to be contradictory. The bogey of the south East Asian economic crisis and the erroneous notion that FDI in housing invites speculative elements were raised as justification for holding back permission.
The reasons for the south East Asian economic debacle are now better understood. The south East Asian real estate crash occurred because the sector attracted too much of short-term off-shore borrowed capital and not enough of foreign equity, which FDI takes care of. This resulted in over investment, over supply, excessive speculation and the entry of unqualified developers. Short-term investment in existing housing stock spirals speculative activity, not investment channeled into developmental financing. Thus when we talk about the need for FDI in housing, we must emphasise that it must be only for fresh housing projects and not in existing housing stocks.
Granted, there is a need to monitor FDI in housing, which is why the Foreign Investment Promotion Board (FIPB) route was suggested over the automatic route. Checks and balances could be maintained by stipulating a three – year lock-in period on the principal amount invested, but allowing complete repatriation of dividends. In addition, a certain percentage of the FDI flows can be earmarked towards a fund for LIG housing.
Ultimately, the underlying rationale for FDI in housing is simply because of the sheer size of funds required. Such volumes are not available or accessible in the domestic market. One hopes that the government will be willing to once again reconsider allowing FDI in housing.
Real estate Mutual Funds
The setting up of a Real Estate Mutual Fund can also provide some support to the cash starved housing sector. The Mutual Fund industry in India has received a tremendous boost but presently mutual funds are not permitted to hold real estate assets. But there already are sector funds where the public invests money exclusively in companies belonging to one sector. This concept just needs to be take further to allow investments in real estate. Besides, a Real Estate Mutual Fund would, through the pooling in of resources, allow individuals with small amounts of each to also take advantage of the returns available from the real estate market.
The concept of Real Estate Mutual Funds in India is not new. Introduction of these funds had been proposed almost a decade ago, but the authorities were sceptical due to the erroneous notion that such funds could be speculative in nature. But fortunately today, the mind-set has changed. In fact, at the initiative of SEBI, the Association of Mutual Funds in India (AMFI) had set up a committee has submitted its report and it is currently being studied by the authorities.
Apart from an increased flow of funds towards the housing sector, the advantages of Real Estate Mutual Funds includes imparting greater liquidity into the industry and bringing and bringing about the much needed “professionalisation” into the industry –
First, by employing legal professionals to evaluate and pass judgement on the legal compliance of the property and thereby help reduce the risk of defective titles and
Second, by employing professionals to provide service to keep the properties in good shape or what is now more popularly referred to as ‘facilities management’.
Though it is expected that the authorities will take time before permitting such funds, one hopes that it will be sooner than later.
Access to Long-Terms Funds
For a long time, various representations have been made to the government to permit housing finance companies to have access to long-term pension and Provident Funds. These funds are suppliers of long-term capital. They typically have a low risk tolerance, but do crave for diversification. The mutuality of interest is strong between homeowners and long-term institutional investors. Although in the recent period the government has given some freedom to provident funds in deciding their investment policy, housing unfortunately, has not been their priority.
But some headway has been made. The IRDA Regulations do provide for a mandatory investment by insurance companies in the “social and infrastructure sector” to the extent of 15 per cent. Though further clarifications are required, it is hoped that the housing sector will benefit by getting greater access to long-term finance.
The housing sector will also benefit through some insurance products ; for instance endowment policies can be used effectively to increase liquidity in the housing market. The Endowment Policy will increase the borrowing power of individual property buyers. Individuals would be to avail loans where they pay only the interest through the tenure of the loan and repay the principal at the loan term by assigning their endowment policy to the lender. The endowment policy would serve as an additional means of finance for housing.
Escrow Account Mechanism
During the boom period between 1991 and 1995 developers had invested heavily in land by diverting funds from other project and taking on huge liabilities from banks and financial institutions. With the crash in the markets the value of these investments was eroded. Most banks and financial institutions today have frozen all their lending to the developer community. The main reasons for this being the inability of the developer to repay their debts. To instill confidence in the lenders the developer community would need to organise themselves and bring about greater transparency in their operations. In this respect developers must explore the ‘Escrow’ mechanism to tap funds from Banks and Financial Institutions. Under the Escrow mechanism the loan amount is decided after doing a thorough due diligence of the accounts of the developer. All transactions (inflows and outflows) are routed through a designated Escrow Account, the control of which remains entirely with the lender. The progress of construction is monitored by the appointed auditors who submit periodic progress reports. This system will not be successful without the co-operation, commitment and support of the developer community. HDFC has successfully implemented such a system initially in Mumbai and has subsequently extended it to Calcutta, Pune and Bangalore. As of date there are 26 live cases under this system aggregating a gross sanction of over Rs.144 crores. Three other cases have already been repaid as per schedule.
In the last budged the Hon. Finance minister increased the depreciation on corporate owned housing for employees from 20% to 40%. This benefit has not yet made an impact as very few corporates have taken advantage of this. Corporates must take advantage of the depreciation benefit and provide housing as an added feature in their employee incentive plans. Developers could explore the possibility of collaborating with corporates to undertake corporate housing projects.
Corporates today are giving attractive package to their employees including Employee Stock Option Plans (ESOP). The ESOP scheme attracted high tax as perquisite value and capital gains. The perquisite value of ESOPs was exempt from tax subsequently. Currently corporates often give employees houses at depreciated values that are taxed as perquisites. Similar to the exemption given to the ESOP scheme the perquisite value of houses could be exempt from tax to encourage corporates to provide housing to their employees. Developers could work together with corporates to undertake construction of projects for employee owned housing.
Industry Status for Housing
For a long time the housing sector has been asking for ‘Industry Status’. Bestowing an “Industry Status” on housing and construction activities would enable the private sector to avail of loans from banks at lower rates of interest. But merely according an industry status for hosing is not a panacea and it does have implications for developers. Developers would need to corporatise themselves – instead of functioning in their current, fragmented fashion, where builders have different companies for different projects, a move towards consolidation would be necessary. Easier access to bank credit would also call for a greater element of transparency and disclosure on the part of developers.
Tax Incentives to Promote Housing
While we recognise that the last 3 budgets have provided a tremendous boost to housing and housing finance, there are still a few measures that can further boost the sector.
* Section 80-IB the tax incentive to encourage housing projects still remains a half-baked measure.
* The objective of providing an ifrastructure status to an activity should be to enable funding at a concessional rate. This objective, however, is not being fulfilled in the case of housing due to the anomaly that exists between provisions of Section 80 IB and Section 10 (23 G ).
* Under Section 10 (23G), any income derived out of investment by way of shares or through the provision of long-term finance in an infrastructure project will be exempt from tax.
* “Long – term finance” refers to a period of not less than five years while Section 80-IB stipulates a maximum construction period of three years (approved by march 31,2000 and completed before march 31,2003).
Thus a period of five years from the starting date of construction is require to make this fiscal concession meaningful.
In addition, if housing finance is granted infrastructure status, it would enable housing finance companies to issue long-term tax-free bonds, which would considerably enhance the flow of funds to this sector.
The deduction for interest on housing loans under section 24 (1) (VI) up to Rs.1 lac should be increased to Rs. 1.50 lac in order to cover the interest on housing loans up to Rs.10 lac, which incidentally now qualifies as priority sector lending.
A number of tax incentives for housing have been introduced for individuals in the past few budgets. This has led to a surge in the demand for housing loans. But this does have implications for developers – they must sustain the supply to meet the housing demand other wise it would once again lead to the situation of spiralling property prices.
Finally, consolidation in the real estate industry is a must. And the larger players will bring in credibility in terms of greater transparency and disclosure practices which ultimately will lead to access of long-term funds at reasonable rates.
Excerpt of Mr. Parikh’s Speech in CREDAI’S Meeting in 8th Dec 2000