Although I refrain from writing anything which can be construed a suggestion to policy makers but today I am making an exception. The reason for not doing so is simply because there is no end to it. And the reason for making the exception is the news about government exploring personal income tax cuts to boost demand.
It is the individual’s balance sheet which needs to be boosted to get the wealth effect back; and this can be done without putting the country at risk of a credit rating downgrade.
India’s adult population (above 18 years) is roughly 870 million; out of which 680 million have a total wealth of Rs. 0.7 million or less (www.statista.com), let's call them the Mass. Yes total wealth and not yearly earnings.
Out of the remaining 190 million people, 170 million have a total wealth of Rs. 7 million or less. Let’s call them the Fortunates. The remaining 20 million are richer and let us call them the Wealthys.
If we were to list the financial assets of the 870 million adults in the country who drive economic demand then the Mass (680 million people with wealth below Rs. 0.7 million) would have around 20% of their assets in banks or government saving schemes or gold. 80% of the Mass’s assets by value would be made up of agricultural land or the house that the family lives in. Considering the low wealth levels of the Mass, bulk of their assets would be functional (i..e., agricultural land or occupied house).
The Fortunates (170 million people who have Rs. 7 million or less in total wealth) will again have at least two thirds of their financial assets in real estate specially agricultural land, occupied house or workplace. The remaining one third would be in other financial products and gold. The split would not change substantially from the Mass as the Fortunates would use their higher but still low earnings to first get basic assets like a better house or an income generating land or shop.
Even if we were to assume that the 2.5% Wealthys have a median income which is double that of the richest Fortunate, the median would be Rs. 14 million. Thus at this level also real estate is likely to form a substantial part of total asstes, let us assume a fifty-fifty split.
Therefore basis the above assumptions we can say 97.5% percent of Indian adults have at least more than two thirds of their wealth in real estate in the form of agricultural land, occupied house or place of work.
Now if the prices of these real assets go down the population becomes less prosperous and over a period of time starts feeling it too.
The house that one lives in is not marked to market at the end of every financial year. But the price of that asset forms the pivot of future security and savings estimates, simply because it forms bulk of the savings for bulk of country's population.
One might argue that these real estate holdings are not liquid and therefore do not affect demand. But what cannot be argued is that these real estate assets are bulk of the individual's balance sheet. What cannot be argued is that if your balance sheet shrinks then you become less Fortunate. If one becomes poorer then sooner or later one behaves accordingly. The "how" of it is very important and lack of an elaborate behavioral explanation in no way suggests that it does not happen.
Therefore till the time prices of these real estate linked assets go up we are unlikely to see demand picking up sustainably across the population.
The nominal prices of Real Estate have corrected 20% since 2014 according to estimates. It is no coincidence that growth has seen a steady deceleration in the same time period.
Now what can the government do to revive real estate demand and therefore prices, without taking the fiscal route?
A simple method could be to allow first time home buyers full deduction of interest against their income, for personal income tax purposes. This would effectively reduce the funding cost of home buying by a third without any drag on tax collection as currently home offtake is at a record low.
It would lead to releveraging of the individual's balance sheet with a less risky and now reasonably priced real asset. Noteworthy is that there is no other transaction in which an individual commits herself to an asset which is worth multiple years of her income. Therefore such transactions inevitably result in higher growth with large amounts of money changing hands in such short period of time.
Real estate inventory reduction would help NPAs giving room to banks and NBFCs to lend to other areas of the economy. The resultant uptick in real estate prices will show on the balance sheet of the individual although only as a passing thought; But that passing thought is enough to choose between a Rin or a Surf and sometimes between starting a new business or not.
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