Banking
Double Bonanza for non-resident Indians

The Reserve Bank of India has recently deregulated interest rates on NRE rupee deposits which are beneficial to NRIs who wish to deposit their surplus funds with banks in India. There are, however, some caveats that NRIs should remember before investing in bank deposits in India 

The Indian rupee has been depreciating for the last several weeks and from around Rs44 to a dollar, it has now reached a level of around Rs53 and is hovering in the range of Rs52 and Rs54 to a dollar at present. This nearly 20% depreciation of the rupee has proved to be a blessing in disguise for the non-resident Indians (NRIs), as they not only get more rupees for their dollars, but also higher tax-free interest on their non-resident external (NRE) rupee deposits, now that Reserve Bank of India (RBI) has deregulated interest rates offered by banks on NRE rupee deposits.

With the burgeoning foreign exchange reserves of the country, the rates of interest payable by banks on NRE deposits till recently were regulated by the RBI and it was linked to London Inter-Bank Offered Rate (LIBOR). So the rate offered by banks on NRE rupee deposits were as low as 3% to 4% per annum and the banks had no freedom to offer anything higher than these regulated rates.

With the recent sharp depreciation of the rupee, the RBI has taken a series of steps not only to stem the fall, but also to attract foreign currency into the country. One of the steps taken by RBI is to deregulate interest rates offered on NRE rupee deposits, and many banks in India have consequently during the last few days increased the interest rates on NRE rupee deposits to as high as 10% p.a. for fixed deposits of tenor varying from one to two years.

Let us go to the basics first. At present NRIs can place their surplus funds with banks in India in three different ways.

1. NRIs at the time of emigration to a foreign land would have had some savings with them. Besides even after becoming a non resident, they would be receiving interest, dividends, etc, on their earlier investments, or rent from their property owned by them but now leased out in India. All these funds can be deposited with banks in India in what is called as non-resident ordinary savings accounts (NRO). In fact, the savings bank accounts held by residents after they leave India on employment, etc, gets renamed as NRO accounts in which the NRIs can continue to deposit their local funds originated in India. These surplus funds can be invested in fixed deposits with banks, and they are also called as NRO deposits. These funds having originated in India are normally not repatriable without prior permission from the RBI. But now the RBI has allowed repatriation of these funds up to certain limits (presently up to $1 million a year) and subject to certain conditions. Besides, the interest earned on these NRO accounts is subject to tax deduction at source at a flat rate of 30.9%. NRIs whose total taxable income in India is less than the basic exemption available to individuals under the Income Tax Act can get back this TDS deducted as refund if they file their tax returns in India.

2. The second type of bank deposits allowed in India for NRIs is called NRE deposits. These are called non –resident external accounts, because the funds for opening and maintaining these accounts are required to be remitted from abroad as free foreign exchange. These funds received in foreign currency are converted into rupees and credited to either NRE SB account or NRE fixed deposit accounts of NRIs. The best advantage of the NRE accounts is that these funds along with the interest earned on these funds are fully re-patriable to a foreign country of their choice without any restrictions, whenever required by the depositor. Besides the interest earned on these deposits is totally free from Indian income tax.

3. The third type of bank deposits permitted for NRIs is in the form of foreign currency and they are called Foreign Currency Non Resident (FCNR) deposits. They can be kept in any currency which is freely convertible as defined in Foreign Exchange Management Act (FEMA), namely, US dollar, Canadian dollar, British pound, Euro currency, Japanese yen, Australian dollar, etc. They carry interest at the rates regulated by the RBI and linked to LIBOR and is fixed in the beginning of each month as per the procedure prescribed by the RBI. These deposits with interest are also freely re-patriable and the interest earned in the respective currencies on these deposits is also free from Indian income tax.

The interest rates offered by different banks for all the three type of deposits are subject to change and hence NRIs are advised to ascertain the rates offered by banks by visiting the website of their preferred bank before making investments in India. They can certainly shop for best rates available and decide on the bank most suitable having regard to their convenience and the quality of service rendered by the bank. What is liberalized by RBI last week was that it allowed banks the freedom to fix interest rates on NRE rupee deposits which was hitherto regulated and linked to LIBOR. The rates of interest for NRO fixed deposits were freed earlier and each bank is, therefore, now free to quote their own rates for both these type of deposits, subject to the condition that these rates cannot be higher than those offered by them on comparable domestic rupee deposits to Indian residents.

In order to facilitate smooth banking operations for NRIs in India, the RBI has recently permitted following facility to NRIs who wish to bank in India. With effect from 22 September, 2011, NRIs are permitted to open NRE/FCNR accounts with their resident close relative ( close relative as defined in Section 6 of the Companies Act, 1956) on former or survivor basis. The resident close relative shall be eligible to operate the account as a Power of Attorney holder in accordance with the extant instructions during the life time of the NRI/PIO account holder. 

There are, however, four caveats mentioned below that the NRIs should remember before investing in bank deposits in India.

1. NRE and NRO deposits, being denominated in Indian rupees, are subject to exchange risk. The rate of exchange being volatile and since nobody can predict the future, the Indian rupee can depreciate or appreciate depending upon the conditions of our country’s economy as well as the global economy. Therefore, when these funds are to be repatriated abroad on a future date, the exchange rate prevailing then will be applicable which may result in capital loss or profit. In short, the exchange gain or loss will be squarely on the shoulders of the NRI depositor.

2. Though income earned on NRE and FCNR deposits at present is tax-free in India, it may be taxable in the country where the NRIs live and they should, therefore, consult their tax advisor in the country of their residence to be clear about the tax implications of investing in India. There are certain double taxation avoidance treaties between India and many countries of the world, which may mitigate the tax burden to some extent, but this can best be ascertained from the tax advisor before investing in India.

3. The rules of investment in India by NRIs are framed by the RBI under the Foreign Exchange Management Act and with regard to tax by Government of India under Indian Income Tax Act and they are, therefore, subject to change from time to time. NRIs are advised to consult their financial advisor for any clarifications in this matter.

4. The chances of commercial banks in India going bust are remote, if past experience is any indication. Whenever any commercial bank is tottering, the RBI normally wears the hat of a marriage counselor and arranges to marry or merge a weak bank with a strong one, so that the depositors do not lose money, though shareholders may or may not get their full investment. But the same can not be said of co-operative banks.

(The author is a banking & financial consultant. He writes for Moneylife under the pen-name ‘Gurpur’)
 

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COMMENTS

Bhalachandra Singde

5 years ago

Can Mr. Gurpur throw some light on the investments made by Oversees Indian Origins, who opted that country's citizenship, and are not termed as NRIs? If such persons wish to invest in India what are the benefits that they may get and what are the obligations on them?

Vinay Joshi

5 years ago

Gurpur,

[Pseudonym is of no use, identity can be established instantly.]

A dip in India’s foreign currency assets resulted in a $4.67 billion decline in the country’s forex reserves to $302.1 billion for the week ended December 16.

Foreign currency assets fell by $4.668 billion to $266.968 billion for the week, the RBI said.

When UAE, tax free, banks are offering attractive loans to expats for investments into NRE/FCNR a/cs why the same should be a concern?

Even 10% is an as offer by a private bank?

Will not talk of fiscal deficit but current a/c deficit is tantamount to financing domestic needs thro" foreign country savings!

What is our savings ratio to GDP?

The bearish trend escalated by Euro crisis esp in emerging markets has a breather as US is in resilience with Germany stable.

As a matter of fact inflation adjusted depreciating INR is on its path, good for growth instead of artificially depreciating it!

Before Q4 it should be at 49/49.5 or so, NRE/FCNR will have more returns which can wipe the cost of borrowing & enjoying the free iPad with the loan availed!! But no funds are coming.

Current a/c deficit reduction unlikely with rising fiscal but by June 2012 foreign currency debt repayment of 139Bn$ due - approx 43% of present reserves.

The funniest part is out of PIIGS [ Portugal, Ireland, Italy, Greece, Spain] Italy enjoys a rating 'A' downgraded from A+ with negative outlook.

The ECB's providing $645bn to Italy in three year tender is tantamount to support battered sovereign debts.

What is India's rating w/o sovereign debt probs?

No one will support India & we will be back to 1991 & the same person is bound to resolve it IF AT ALL SUCH A SITUATION ARISES! GOD FORBID!

No, with the present turmoil & macro economic situations anything possible.

Regards,


Anil Agashe

5 years ago

As usual banks are going over board with the high rates they are offering. How are they going to lend these funds? At what rates do they think borrowers will be attracted to borrow? The rates offered seem mindless. Their cost of borrowing is going to rise. RBI has paused and food inflation is down. So in the new year one may see reduction in interest rates.

REPLY

Vinay Joshi

In Reply to Anil Agashe 5 years ago

Dear Mr. Anil Agashe,

Where is the liquidity in banking system?

Last Friday 23, banks borrowing stood at 1.73 trillion rupees, incremental 7K Cr over previous week [1.66trn]!

Regards,

anil agashe

In Reply to Vinay Joshi 5 years ago

What are they doing with this money? Their NPAs are rising. It wld be better for RBI to cut CRR if banks need liquidity. That will be profitatable for banks than borrowing at such high rates.

Vinay Joshi

In Reply to anil agashe 5 years ago

Dear Mr. Anil Agashe,

What are they doing with this money? Your quest! Definitely they are not keeping it for themselves!

What is the correlation of borrowing – NPA – CRR? Please can you answer, if at all!

What is CRR?!

Last Friday 23, banks borrowing from RBI stood at 1.73 trillion INR.

Why should they borrow? Which high rates are you talking about? Hearsay!! Explain.

It seems my response to Gurpur was incomprehensible to you.

What is the banks borrowing rate & norms of their borrowing? from which sources?

Already leeway [-] 1% SLR there exceeded by 1.91%.
The Govt.’s fiscal arithmetic gone awry so this fisc borrowing heavily.

DEC 30, 15KCr bond issue, earlier 4KCR auction was cancelled.

As far as asset quality is concerned it’s diff an issue.
No CRR cut. It will be only when RBI wants to intervene in forex & mop-it-up against the $ released. Not in the near future. Its complex.

Regards,


rohan

5 years ago

Hi

dilip kr sarkar

5 years ago

its a bonnza for our economy . kudos to RBI.

Coastal Road: For whom and for what?

The Coastal Road, like most projects conceived by the government, does not seem to be an investment towards making an equitable facility in a society with democratic values and polity. In absence of an efficient road public transport, even the 57.5 hectares of ‘open spaces’ created by the project becomes inaccessible to the majority of 125 lakh resident Mumbai citizens.

The Municipal Corporation of Greater Mumbai (MCGM) has prepared a plan for a ‘Coastal Road’ on the western sea front. This is being planned by widening the road by ‘reclaiming’ land 100m into the sea from the present sea line, providing elevated roads at certain sections, providing road over stilts at inter tidal zones where mangroves exist, bridges where required, connect to the Bandra Worli Sea Link (BWSL), and tunnels under the Malabar Hill and Marine Drive. This road shall be a 5+5 lane ‘highway’, (though the BWSL is of only 4+4 lane width) to let motorcars to travel at high speeds. It also proposes to provide as a ‘bonus’ some 57.5 hectares (Ha) of open spaces. The open space is equivalent to a width of about 20m, the entire length. Only a detailed report will reveal how easily this is accessible to pedestrians and public transport users, especially those in the denser interior parts of Mumbai. (Click here for map depiction)

It is said to follow the CRZ-2011 norms, which apparently has been devised for Mumbai to accommodate a coastal road concept proposed in the Mumbai Metropolitan Region Development Authority’s (MMRDA) Comprehensive Transport Study (CTS-2008) Report and further supported by the Singapore-based Urban Development Consultants in their “Surbana” vision plan. While the Union ministry of environment and forest (MoEF) is likely to give a green signal to this project, the only hurdle could be that there is the extension of the sea line by 100m, which if the MoEF is convinced that the Coastal Road is most necessary from the ‘traffic decongestion’ point of view will lessen air and noise pollution, giving green signal will be absolutely no hurdle at all.

The question to ask is,
(a) is the Sea Link too expensive (Rs15,000 crore)?
(b) that other means of lessening the overall road congestion been seriously considered, such as introducing BRT (bus rapid transport) system whereby public transport gets a boost over use of private vehicles leading to significant lowering of air and noise pollution all over Mumbai?
 

The 29km of Coastal Road along the west coast of Mumbai is estimated to cost Rs6,000 crore, much less than Rs15,000 crore for the Sea Link right along from Versova to Nariman Point. It is part of the "Ring Road Concept" propounded by planning consultants whose background is to develop systems which are motorcar-centric, rather than mobility of the people as an objective. To that extent it is flawed. Some points to consider by the planners, the Government of Maharashtra and all the stake holders are:

1. Only 2.8% of Mumbai population use motorcars. A sea link or Coastal Road will cater to only a small fraction of this small proportion of Mumbai’s population, for which Rs6,000 crore is being sought on a priority basis.

2. Of the 125 lakh resident Mumbai population (Census 2011), a majority of the population use suburban railway system (75 lakh) and BEST bus transport users (38 lakh, 75% of whom use railway in addition) are subjected to super crush load and road congestion respectively. 3.1% using bicycles and 44% who exclusively walk to work and on the whole, almost 95% of Mumbai population walk some distance or the other. These large proportion of users of carbon neutral modes of transit have very little to feel safe and comfortable with the existing infrastructure and the currently proposed infrastructures such as coastal roads or sea links.

3. The ring roads concept of urban development is quite understandable for urban areas which have growth possibilities in all directions. With the main central business district (CBD) located at the centre, minor CBDs work out well along the inner or outer rings or if the sprawl is much larger, extra outer ring roads. For the MCGM areas in Mumbai, this concept is inappropriate as a major length of the “Ring Road” has no developmental possibility at all as far as minor CBDs are concerned and again, not at all for any other purpose on the seaward side.

4. As has been the case with utilization of BWSL, this coastal road will be poorly utilized in numbers as well as proportion of population. In comparison to the sea link option, the coastal road being almost one-third the cost, purely in terms of economic consideration between the two options only, the coastal road scores over the sea link. It’s providing 57.5 Ha of open space as bonus also goes in its favour. However, the project does not address the mobility issue of 95% of Mumbai population.

5. The coastal road as well as a sea link will be of little value to the population (38 lakh) using BEST buses and thereby even to possible users of BRTS—if BRTS is brought onto the agenda of Mumbai Mobility plan.

6. For Rs6,000 crore, a network of 400 km of BRT system could be established, increasing mobility of Mumbai on the whole, providing alternative facility to motorcar users who otherwise would be on congested roads and more importantly, avert annual 4,000 fatalities taking place on suburban railway system by significantly reducing the commuter load on it.

7. Help towards the long-term objective of reducing adverse impact on global warming and climate change.

8. Providing priority to projects such as the coastal road would only encourage use of personal motorcars and would go contrary to the National Urban Transport Policy of prioritizing walking, cycling and the BRT system.

9. The coastal road does not seem to be creating accessible open public space to the 125 lakh people that Mumbai holds. Also, it does not seem to be an investment towards making an equitable facility in a society with democratic values and polity.

(Sudhir Badami is a civil engineer and transportation analyst. He is on Government of Maharashtra’s Steering Committee on BRTS for Mumbai and Mumbai Metropolitan Region Development Authority’s Technical Advisory Committee on BRTS for Mumbai. He is also member of Research & MIS Committee of Unified Mumbai Metropolitan Transport Authority. He was member of Bombay High Court appointed erstwhile Road Monitoring Committee (2006-07). While he has been an active campaigner against Noise for more than a decade, he is a strong believer in functioning democracy. He can be contacted on email at [email protected])
 

 

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COMMENTS

Nagesh Kini FCA

5 years ago

In addition to the beaches at Chowpatty and Juhu, the Shivaji Park is wrongly stacked with huge black boulders completely destroying last of the open spaces. The BMC Chief Hydraulic Engineer has gone on record to say all of Mumbai's beaches will be gone by 2018. With this new hare brained proposal it may be sooner.

Shama Zaidi

5 years ago

As you can see both the beaches at girgaum chowpatty and juhu chowpatty are going to be destroyed. When there are no open spaces why are they insisting on this sea-coast link? And the Airport Authority insists on extending the juhu Flying Club runway over the beach onto the sea. Should not the Juhu Airport be relocated and the space used for three roads joining Vile-Parle and Santa Cruz? The trams were removed 20-30 years ago, which again was a stupid thing to do. But such is the power of the car and builders' lobby and their ability to bribe politicians and bureaucrats that they can selfishly and shamelessly go ahead with these cockeyed schemes, which do not benefit the generak public. Look at the money spent on the Sealink and walkways, and see the underutilisation of the same if any proof were needed.

Shama Zaidi

5 years ago

while on the subject of footpaths, "world-class cities" have uninterrupted footpaths, which house owners have to access at their own cost. Not like in our cities where footpaths are cut up for the convenience of house-owners. Also our footpaths are sometimes 30 centimetres higher than the road instead of the conventional 15 cm. So that is why we walk on the road rather than the footpath.

Sudhir Badami

5 years ago

MCGM has placed the report on Coastal Road at http://mcgm.gov.in/irj/portalapps/com.mc...

I have just down loaded it but yet to go through it.

Sudhir Badami

5 years ago

Unmesh, All the infrastructure projects take a long time. The coastal road is stated to get completed in 3 years. Money is not easily available and all kinds of excuses are created to delay and get money raised to pay. Therefore, W, C & BRTS have to be put on priority while other projects may be considered.

So long as the 2.8% of the population is pandered to, you will never be able to provide for the overwhelming majority of commuters.

In addition to transportation solutions, it is a matter of Democracy reflected on every shade of our existence and on road in particular very visible.

REPLY

vishvas

In Reply to Sudhir Badami 5 years ago

sir, what is ur opinion @ waterway between nariman point & borivali

nagesh kini

In Reply to Sudhir Badami 5 years ago

What 3 years to completion are you talking about? The Rajiv Gandhi Setu that our friend SP christened Bandra-Worli Link Bridge over ran both the time and the money. Building another monstrosity to pander to just 2.8% of car owners is sheer waste of your and my money. It has to be shot down with a bofors gun here and now.

Sudhir P Badami

In Reply to nagesh kini 5 years ago

Mr Kini, I think we have no place for Guns, of whatever make, in our democratic set up. We must exercise restraint if one feels upset with different opinions.

nagesh kini

In Reply to Sudhir P Badami 5 years ago

Sudhir - please note I didn't hold the gun at you.
There is no question of restraint when one feels upset. My blood literally boils when I see the Sea Link day in and day out. I've seen it coming out from a scratch and the time and money overruns and now what is the usage?
And yet another one from Worli to Nariman Point when a more cost efficient water transport skirting the entire western sea board would have just as good.
The Peddar Road flyover in my opinion is only an ego settlement issue, since big names are involved, empty air balloons.
You think they can bring it about in the scheduled time?
Let's be realistic please.

Sudhir Badami

5 years ago

All these arguments of BRTS could be part of the 'integrated system' is the language of conventional planners.

All that can come when you prioritize infrastructure for Walking, Cycling and the BRTS. Prioritizing means you not only bring that onto the agenda (currently for the past three years it has been systematically kept out of consideration - world class cities do not have buses you see, they run Metros and personal cars - ) but make that as the centre of planning the 'integrated system.

REPLY

unmesh

In Reply to Sudhir Badami 5 years ago

Dear Sir,
i meant .........let this coastal road be a part of a grid which exsist surburban rail at one end and brts as on of the arms to complete the network.

once people get options to commute ,it will also lead to giving away their vehicles .
for e.g a person staying at versova shall opt to take coastal road instead of surburban rail while commuting to nariman point .....and vice versa .....a person stayting near stn would depend upon surburban rail .

i only empahsized that if the grid of public transport system is complete is turns effective ,,,,, walking , cycling ,brts must be part of this grid ...............

i need yr view point .

sir dont mind , pl ignore if u found my comments incorrect ..........i am to small in exp with you ,but couldnt stop my self to comment .....as public transport fascinates me to comment .................

Regards
Unmesh

unmesh

5 years ago

sir ,
its better if we view this coastal road concept as part of integrated network and can ,brts be part of it this ! point to point bus may prove effective thus will split the crowd and shall allow

Regards
Unmesh

Sudhir Badami

5 years ago

Though motorcar users constitute only 2.8% of Mumbai population, some of them do not believe in having a transportation system that provides mobility for all. If they were to pay for all the facilities the government provides for the small numbers they are, they too will not be able to sustain it financially and make hue and cry about it.

Looks like I have not put across certain salient points to convince Mr Adi Daruwala that we need to provide adequately for safe and comfortable commute to all, starting from pedestrians, users of NMVs and Railways and Road Public Transport before providing for the needs of personal motorized vehicles - given the demography of modal distribution and income levels.

The affluent are enjoying the largess for the large number of poorer people. Does it ever occur that there is some injustice here?

REPLY

Adi Daruwalla

In Reply to Sudhir Badami 5 years ago

Mr. Badami, when I say crawl, even the common man is crawling today under the pressures of poor infrastructure, even the BEST crawls, the trains also crawl, and nothing happens on time. So i am not referring to only the affluent public here, and that notion of affluence should be removed when we are talking about public projects. I would very much like you to list the salient features PLEASE and in what time frame can they ease the common mans pressures in Mumbai???

Sudhir Badami

In Reply to Adi Daruwalla 5 years ago

Precisely what I am saying. Keep adding infrastructure to provide for smooth flow of motorcars, more motorcars come on the road, nullifying every effort and great expenditures. Everyone crawls except those in the trains, but then trains are so overcrowded that....

Please read some articles I have written and posted on my website. https://sites.google.com/site/sudhirbada...

We can definitely discuss on the subject, perhaps when we meet? Or at a seminar?

Adi Daruwalla

In Reply to Sudhir Badami 5 years ago

Yes we can discuss at a seminar, but I think that if infrastructure improves, then only 2.8% of motorists benefit and that motorist ratio increases in a small number. The balance benefit is going to the public at large, so I see a rather skewed comment here. Along with roads the number of railway rakes and the no of buses also need to increase. BEST should be made an investor in road projects. The incrase of rakes and buses is waht is not happening?????

Badami

5 years ago

Well written piece, I hope this does not come through, it will be surely and utter waste of money and time, the money can be used for improving existing infrastructure.

SANarayan

5 years ago

Taking off from what Mr Badami says, why cant the city planners be given a specific task of working out plans for increasing capacity and,amenities and facilities for local train and BEST passengers and ignore motorists in this exercise. Civil Society should put pressure for this agenda.

REPLY

nagesh kini

In Reply to SANarayan 5 years ago

Mumbai's motorists are in deed a pampered lot with roads, flyovers, sea links and all these money guzzling high end services that they don't deserve.

Broader pavements and foot paths, cycle tracks should be the solutions that are more non-polluting and cost effective.
No more petrol, diesel, cng cars.
Follow the Singapore model hike car prices and taxes.

Adi Daruwalla

In Reply to nagesh kini 5 years ago

From which side do the motorists look pampered? How many years since we have seen any dvelopment and improvement towards decongestion and less crawl?? Tata is coming out with a car that will run on air by Aug 2012. Your pollution worries should be over after that. and so should Lata Mangeshkar's also, so that for the sake of the nightingale of India, then if Tata's new product is successful then at least Worli to haji Ali Sealink can be built. That does not solve the overall Mumbai problem. There must be a complete solution end to end. Nariman point to Virar.

Shama Zaidi

5 years ago

the plan includes destroying Juhu beach so that 10,000 cars can zip into town faster everyday . the cheaper and simpler alternative of relocating juhu flying club and passing the three truncated roads at either end through it has not been considered for obvious reasons.

Sudhir Badami

5 years ago

I would like to provide link to the column I had written on this web-magazine covering the Sea-Link from Versova to Nariman Point. http://moneylife.in/article/a-matter-of-...

Nagesh Kini FCA

5 years ago

With only 2.8% cars what is the big idea of spending crores that multiply many times over like the bandra-worli sea link?
with the cbd moving north wards to bkc as also with nariman point and fort going out of fashion does it still need to be connected?
this is violation of crz and coastal fishing. it is a big no-no!

Paul

5 years ago

More land needs to be reclaimed from the sea off Bombay. BTW ( By The Way ) most of the naysayers for reclamation ARE LIVING IN RECLAIMED BOMBAY !

Adi Daruwalla

5 years ago

Who establishes that only 100m from the current sealine needs to be developed? Why not 200m?
When you talk about BRT which is MRT (Mass Rapid Transport), where is the existing road infrastructure to implement a BRT/MRT?
Why BEST will not be permitted to use the coastal raod, or the BWSL? Make BEST an investor in the project and give them free access to coastal road and BWSL for"X" no of years.
For 12000 crore a 200m wide 400km road could be developed which is better than the 15000 crore spent on Sea Link.

REPLY

Paul

In Reply to Adi Daruwalla 5 years ago

Agreed.The Coastal Road is more permanent and business friendly.The sea link is a security risk.

Foreclosure after real estate bubbles burst in EMs

A burst real estate bubble in emerging markets would be far more severe and would last much longer. The reason is simple. The legal plumbing in these countries, including foreclosures and bankruptcy laws, is either deficient at best or nonexistent at worst

It took some time, but they are finally beginning to get it. Leading financial analysts, money managers and economists have commenced to comprehend that real estate bubbles in many emerging markets could crash. The Nobel Laureate economist Paul Krugman wrote in his New York Times column that China was another emerging danger as its credit fuelled real estate bubble burst. The same concept has at last dawned on hedge funds A hedge fund owned by the famous private equity firm Carlyle sent an elite strike team to do a “deep-dive research trip” to China. It won’t help. They might find what is, but they have no idea of what is to be.

To find out we have to look at what was. The US state of Texas had a real estate bubble in the late 1980s. When the bubble collapsed, banks were stuck with massive bad real estate loans. To solve the problem the US created one of the first “bad banks”, the Resolution Trust Company (RTC). The banks transferred the bad loans to the RTC along with the job of foreclosing on and selling the property.

The RTC tried to do its job, but was stopped when local real estate interests complained loudly that sales of foreclosed property were depressing the market. When the RTC stopped selling, the market froze. The buyers stopped buying, because they knew the RTC would eventually have to clear its inventory. After a time economics overcame politics and the sales restarted.

Today the US has a similar problem. Almost 30% of houses sold in the US in 2011 were the result of foreclosures. Over 3 million homes have been foreclosed since the real estate market collapsed. But the market still has not cleared. Although many of the foreclosed homes do get sold, they make up less than one-third of the houses that the banks actually repossess. The banks are slowly leaking these properties on to the market, because they are terrified that too much distressed inventory would depress prices further. The result is that the recovery has been slow. But at least the process is going forward, which is a lot better than nothing at all.

The US is not the only country that has experienced a real estate bubble. The easy credit sloshing around emerging markets has had a dramatic effect on property. Luxury homes in Mumbai and Singapore have increased by 138% and 144% respectively over the past five years. Real estate in India grew 400% from 2003 to 2008 before the crash and now in some places it is 30% higher than its 2008 peaks.

Prime office rents in Rio de Janeiro are higher than anywhere in either North or South America including New York. House prices in Sao Paulo have nearly doubled since 2008. Some areas of Rio’s fashionable Ipanema district have risen over 30% since last year.

Then there is China. Home prices in Beijing have risen by about 150% in the past four years. Like India, they have increased 400% since 2001. Beijing theoretically began to tighten lending especially to real estate two years ago, but their efforts have not been rewarded until the last few months when property prices started to decline.

Contrary to some true believers, all markets go down as well as up, even emerging markets. Prices are beginning to fall and the falling prices have begun to accelerate.

The consequences of a real estate bust in emerging markets would create quite a different situation than the real estate bust in developed markets. The rules are much different and so would the outcome. A burst real estate bubble in emerging markets would be far more severe and would last much longer.

The reason is simple. The legal plumbing in these countries, including foreclosures and bankruptcy laws, is either deficient at best or nonexistent at worst. There isn’t even information on it. Despite diligent search in all financial news sources and general internet search, I have found few if any references to emerging market foreclosures.

Many economists like to point out that mortgage lending in these countries is still quite small and often requires large down payments. True, but it has been growing at 20% a year in places like India. In China bank-financed construction makes up twice the percentage of the gross domestic product (GDP) as it does in developed countries.

For a country to grow after the crash of a real estate bubble, the market has to reach equilibrium. To do so requires that over priced homes with delinquent mortgages have to be foreclosed and sold. If the procedure for foreclosure doesn’t exist, then the entire economy gets stuck with massive dud loans and zombie banks as occurred for over a decade in Japan. So when the emerging markets collapse, the recovery will take years.

(The writer is president of Emerging Market Strategies and can be contacted at [email protected] or [email protected]).

 

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COMMENTS

Grant

5 years ago

We all realize that much of China real estate is worthless and falling apart. This is why no one who has real money wishes to live in these buildings. Everyone wishes to emigrate to a far better clime. We all know this to be true.

Grant

5 years ago

Perhaps now is the best time for some of the real estate developers to take a few deep dives of the rooftops of the worthless buildings they build. What about this?

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