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Does Demonitization Spell The End Of The Indian Real Estate Bubble?

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  • BHC Team

In case you have been stuck under a rock or completely disconnected from the outside world, it should be mentioned that the Indian Government recently demonetized old currency notes of Rs. 500 and 1000 only to replace the same with new Rs. 500 and 2000 notes. In his announcements, Prime Minister Modi said that this move was made in the effort to limit the influence of black money on the Indian economy and eliminate counterfeit notes. While this move has been heavily debated, one inevitable outcome of the move can already be seen in the fall of real estate prices across the country.

Typically, real estate transactions in India happen with a large component of the sale being in cash. With the current demonetization and current shortfall in cash, prices will only fall to naturally compensate for the loss in the cash component. Further, the government plans to launch new Rs 500 and Rs 2,000 notes. It will not be so straightforward to exchange the old Rs 500 and Rs 1,000 notes with these new notes, at least that is the feeling that currently prevails. Moreover, more black money being deposited in the form of old currency bills is subject to increased scrutiny by the income tax department, further discouraging prices.

This is the logic being offered by experts who are forecasting a fall in real estate prices. As Yashwant Dalal, president of the Estate Agents Association of India told the Economic Times, "Property markets will see around 30% correction in prices...Apart from big property markets, tier II and III cities will be worst affected." Property prices in tier II and tier III cities will fall more because the black component while buying a home is higher in these cities. Further, as Anuj Puri, chairman and country head, JLL India, told Mint: "We have just witnessed a tremendous step towards increased transparency in the Indian real estate industry...The effects will be far-reaching and immediate, and shake up the sector in no uncertain way." Rajiv Talwar, CEO of DLF, was a little more direct than Puri when he told The Economic Times: "There is bound to be a downward pressure on prices of everything including real estate."

However, whether or not the real estate bubble will burst, depends solely on the government. In 2008, after the crash of Lehman Brothers, the global real estate market exercised corrections by reducing prices, but India stayed relatively exempt from the action. This was primarily due to cooperative and public sector banks issuing fresh loans to the real estate developers to pay off their old debts, in order to not reduce the selling price of real estate already in its development or completion state. If the same phenomena follows suit in the wake of the current demonetization, it will be improbable for the real estate market to maintain its current downturn.

The above notion is further enhanced by the comments of Vivek Kaul, the editor of an Equity Master blog. He says, "This was a huge anomaly. It is safe to say that this was a bank-sponsored bailout of the real estate sector. If this bailout had not been carried out, real estate companies would have had to cut prices majorly to sell homes, to be able to earn enough money to repay the bank loans that they had taken on. Chances are they would have defaulted on some of these loans as well."