India's Sub Prime

Joe Leahy in the Financial Times has written about India’s own version of the subprime crisis in the form of rising delinquencies of personal loans and credit card payments.
http://www.ft.com/cms/s/0/c03d934c-f06c-11dc-ba7c-0000779fd2ac.html
Not for the first time, if this snowballs into the kind of crisis that we are seeing in the US, its roots will lie in the excesses of the past 2-3 years. There is a direct link between those pesky calls from barely literate people selling "no income proof-needed" credit cards and "no questions asked" loans and what some banks have now started to mention at least in private. Simply put, some of those loans aren't coming back. Give a 24-year old five credit cards, a credit limit which far exceeds her annual income, and the outcome is a spiral of defaults. The same is the case with loans which were given more against hope than any real repayment capacity. In their eagerness to rope in more customers, banks have been throwing all caution to the wind. It has to catch up some day.

I wrote about it in the Financial Express, 15 months ago:

Boom or bubble
Housing loans are cause for worry
In Greek tragedy, the legend “Nothing to excess” resonates through the tragic life and end of King Oedipus. When a house in a distant suburb of Delhi is priced at Rs 1.5 crore (that’s almost $350,000) and bought by a 30-something couple, thanks to the magic of leverage, it’s time to read the oracle’s words again. Leverage is a double-edged sword. Sure it allows people to buy a multi-crore condominium by putting down just the Rs 10 lakh they have. But when things turn sour the losses are equally amplified. Just a 10% decline in the price of the property would mean that the borrower has lost 100% of his money. A rule of thumb that property America has used is that fair house prices are 125 times the monthly rent. Across Delhi, Mumbai and even the suburbs it’s now closer to 250 times. An unholy concatenation of low interest rates and high growth in income with a consequent impact on the asset value has fuelled this mad rush to acquire property. Interest rates on housing loans for a 20-year tenure have dropped from a high of 13-14% in 2000 to about 7-8% in 2006. The consequence has been a mortgage-driven housing boom. The only agency with little to gain from this bubble, the RBI, in its recent occasional paper stated, “It is alarming to find that real income growth played only a minor role in determining housing prices in India”. Its norms for lending to the real estate sector have been getting stricter. After blocking funding for purchase of land, the central bank has further tightened measures for checking flow of funds from banks to the real estate sector. It has asked banks to ensure that credit disbursed is used only for “productive construction activity.” There’s another worry – the traditional source of home finance – housing finance corporations which are specialized to assess housing-related risk and are more rigorous in their evaluation criteria – have lost market share to Indian and foreign banks. Their share of the market has dropped from 60% of outstanding loans in 1999 to about 35% last year.

If and when this bubble bursts, there won’t be a “soft landing”. And to those confident that this is one bubble that’s going to keep growing, it would be good to remember that unusual events happen more often than one would expect. Any burst of severe volatility could lead to grief for the economy as whole. IMF research reported in the World Economic Outlook indicated that output losses after house-price crashes in developed countries have, on average, been twice as large as those after stock market crashes, usually resulting in lasting recessions. For an economy that has just started on steroids that’s a sobering thought.

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