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.
posted by allinsurance @ 5:00 AM
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