Last Updated : Nov 17, 2016 10:16 AM IST | Source: CNBC-TV18

Demonetisation: To widen tax base, push interest rates lower, says Deepak Parekh

Market is over reacting to demonetisation move and Trump-win. India has never been in a stronger position as it is today, says Deepak Parekh, Chairman of HDFC.

Terming government’s demonetisation move as "bold, game-changing and transformational", Deepak Parekh, Chairman, HDFC stressed it is necessary to go through this pain for a better future.

In an interview to CNBC-TV18 Parekh said it is the biggest of all big-bang reforms undertaken by any government so far.

Giving the rationale behind this move he said government had given enough warnings (election manifesto, renegotiated tax treaties, income declaration scheme etc), and so it was absolutely necessary to eradicate black money created over decades.


This will also help widen the tax base in India, which has so far been very low. Tax to GDP in India is the lowest in the world, he added.

According to him, there is all likelihood of land prices going down, secondary real estate sale prices falling and one can see a decrease in loan against property. However, on the positive side, since the government is keen to kick-start the economy again, interest rates could come down to the tune of 0.5-1 percent next year, real estate prices will be more in white and builders may have to bring down prices to increase liquidity.

However, he is certain that impact on real estate will not completely stall activity in that sector and does not see people losing jobs because of this move. He is also certain that consumption will come back once the withdrawal limits are relaxed.

When asked about its impact on stock market, he said he was not sure why the stock markets took the demonetisation move, Trump-win in US so badly. Market is over reacting to both these news.

India has never been in a strong position that it is today, he said.

Below is the transcript of Deepak Parekh’s interview to Latha Venkatesh on CNBC-TV18.

Q: What do you think of the event itself? Is it a deep reset?

A: I think it is a game changer. It is transformational. It was very necessary and it is a very bold move by the government and it is probably one of the biggest big bang reforms undertaken by any government for a long time. Why is it necessary? There are a number of reason why it is necessary. First of all, if you look at our currency system, India is a cash based society. 70 percent of value of transactions are in cash and even our gross domestic product (GDP), 45 percent of our GDP comes from informal sector. Informal sector accounts for 80 percent of our population. So, if you look at our currency in circulation, India probably is one of the highest currency in circulation ratio. It is almost some 16 percent or so or 13 percent. And if you look at our, about Rs 17.5 lakh crore is currency in circulation. 86 percent of that is in Rs 500 and Rs 1,000 notes. That means about Rs 15 lakh crore. So, this Rs 15 lakh crore will have to be redeposited by the people in the banks to their credit or their accounts, whatever comes. Up to now, the figures that I hear is about Rs 4 lakh crore. So, Rs 4 lakh crore has already been deposited by the individuals in their bank accounts.

Now, if you see, there are different estimates of black money in India. The world bank estimate is about 20 percent of GDP. Indian government’s rough estimate is about Rs 10-15 lakh crore. So, these are different estimates which is much lower than 20 percent of GDP. Now, it is again very difficult to estimate how much of this is in cash. How much of the black money is still in cash because normally it is invested in land parcels, paying for approvals, gold, foreign currency, remittance abroad illegal. So it is in a number of areas. So, no one knows how much black money is in circulation.

Now 3-4 reasons why I think the government, why I felt it was absolutely necessary to have done this and really the government needs to be given credit for it although it impacts the common man. There has been a lot of hardships, there has been inconvenience, there have been long queues in the banks. Common man is impacted, but there was a survey done by one newspaper which said 86 percent or 82 percent of the people interviewed said it is a very good thing for the economy. So, maybe pain in the initial phase, first quarter, but then things should be much better because we are eradicating black money created for decades by one move. To create black money of that size is going to take years. You cannot create black money over night. First you have to earn the money, then if you do not declare it, then you create the black money. But first the earnings has to be there.

Q: It is believed that the real estate sector, to a large extent is financed by this accumulated black money. How do you see the real estate sector getting impacted? Do you see the land prices for instance, halving or house prices?

A: Before I answer that, I wanted to say what is the rationale, logic or reason, why this was necessary. First of all is counterfeit currency. We are being plagued by counterfeit currency and the estimate is about Rs 400 odd crore of counterfeit currency is in circulation. Predominantly Rs 500 notes. And so it was necessary to demonetise the Rs 500 currency notes because of counterfeit. And the intelligence sources, intelligence agency feels that there is a printing press across our borders which are printing these notes for nefarious activities. So, it is the safety of the nation, the security of the nation. Even if it means inconvenience and hardships, this had to be done. And we understand from the RBI that the new notes are different, there is more security ink, security paper, it will be difficult for anyone to copy it. So, that is one reason, counterfeit.

The second reason was black money. This large amount of black money, how the menace of black money where unaccounted money, unaccounted for tax money is in circulation, how do we get that out of the system because it is not fair for some people to use the cash when not paying tax. So, the point here was that we have to widen the tax base. They are only 2.5 crore individuals who are filing income tax returns, many with nil. So, the tax net has to be widened. Tax to GDP in India is one of the lowest, it is 10.6 percent or so. It is one of the lowest in the world. 10.6 percent is equal to African countries. Not even the BRIC countries or other Asian counties have much higher tax to GDP ratio. So the government has to increase the tax net and that was another reason.

And political also, in politics also during elections and all, election funding is normally in India done with unaccounted money. So, there are a number of reasons why the government had to do this. Now enough of warnings was given for the people. If you look at the warnings given by the Finance Minister and the Prime Minister, first of all it was an election manifesto that we will bring black money out, we will punish people, we will go after people who have black money. They renegotiated tax treaties. OECD had an understanding with them that anyone Indian origin who have bank accounts in the OECD countries could be informed the government. Tax havens, agreements are there with the tax havens that information will be passed on to the Indian government from the tax havens. Then the black money bill of 2015 which was to bring foreign money back, this did not help because only Rs 2,500 crore came back.

And finally, was the income declaration scheme which just ended in September. Here the government says we collected Rs 65,000 crore and about Rs 30,000 crore tax has been collected. Out of all these warnings, Rs 10-15 lakh only a small amount has come out, so the government had to do this.

Q: I take your point that the government gave enough warning before this big strike. But the point is the impact. Informal economy will exchange the cash. But what happens to the unaccounted economy, in particular, real estate.

A: Real estate, for someone like us, our business will grow faster because 85 percent of our borrowers are salaried class. We are restricted by giving loans to them on the agreement value. Now if the entire agreement value is in white, the loan amount will go up. Our borrowers who are salaried class like you and me, we have to withdraw money from the bank to make it black. So, the average size of the loan has to increase if black money goes out of the system. So, the business will increase. What happens is to the smaller microfinance companies and the small banks who get cash payments, for them it is going to be a little more difficult.

Q: Microfinance companies still are a smaller part of the economy. Real estate is not. Now let me begin from the problem. Practically, all the buildings inner city, if you ask for a price, people will give you a 60:40 quote of black and white. In Delhi, I am given to understand people ask for a 50:50 quote. Now, what happens to these kinds of houses? Do you see prices halving?

A: Prices will not halve. More prices will be more white. And the black element should go away or substantially reduce. In certain pockets in the country, I agree there is a large black portion, but somehow in south India and western India, I can show you 90 percent of projects in Mumbai and Pune and around Nasik and Nagpur and Bengaluru which are all check payments.

Q: I am not denying that I have bought two houses in my life time one in New Bombay and one in Mumbai and both are white payments, I am not denying it that will happen, but if I try to get into inner city, the first block was of course the cost of the house, but it was also the big black portion.

A: The root of the cause is land prices and for land aggregators, when people buy land as land aggregators and developed 10 acres, 5 acres and then sell the land to a builder, they pay cash to everyone. My view is the land prices will come down, because first of all so far as the developers are concerned most of them are overleveraged. You know the state of developer and industry, they are overleveraged.

I think excessive borrowing capacity is limited, stocks are there, unfinished unsold stocks are there, incomplete buildings are there if they sell those at a lower price, if they bring the price down the sales will increase - - so they will be forced to bring prices down to get liquidity to complete the construction. So that way I feel it is a good move, there will be pain, first 3-4 months there will be pain. In fact, there will be even pain for many of the borrowers to pay the EMI cheque and one will have to see how this pans out, because every month whether they have to put money in the bank.

Q: I see a series of problems, first let me begin with people who have completed houses, but who are not pushing it, to what extent do you think prices may fall for instance in Mumbai, can they fall by 30-40 percent?

A: See my view is the secondary sale prices will fall much faster than primary sale, because primary you are still getting many flats at full cheque. I agree in north it is little different in certain pockets, but in this part of the world and South India it is very different. Secondary sale many times the society doesn’t allow you to charge a higher amount, because then the whole rateable value of the property goes up. So when people buy a readymade flat from someone else on a resell flat they are forced to pay some in cash because the society disagrees, because the whole rateable value goes up, the outflow of tax goes up and so secondary sales prices will come down faster than the new sales. The existing buildings that are under construction the developers they have already paid for the land.

Q: Since the real estate economy sub-segment runs a lot on black money and that portion of money is burnt or has gone out of the system. Do you think there will be incomplete buildings, those of us who have paid EMIs, are we going to get buildings after two years or something like that?

A: I am sure there will be delays, there are already delays, there are no developer in my history have given a flat on due date. There may be few exception, but there were few exceptions.

Q: But are we going to see inordinate delays?

A: There will be delays, maybe not inordinate, but maybe a year or two to build it in your plan. You have to build it in your plan. See fortunately today all the ingredients are available in plenty, whether it steel, cement, labour, sand and all the ingredient. There is no shortage of raw material. There is no shortage of money and capacity to borrowing is not there, because many builders the banks are not giving more money, because of their exposure limit. So they will have to by force either to sell some land they have at a cheaper price and raise liquidity or sell flats at a lower price and raise liquidity. Their hands are tied now, earlier they had cash which they could used to carry on. Now the cash is going out of the system, how much cash will disappear from the system one doesn’t know, how much cash is not submitted back to the Reserve Bank of India (RBI) we don’t know, but again some estimates are Rs 3-4 lakh crore.

Q: But can it stall all activity. For instance because they have been receiving unaccounted cash, they pay cement guy in cash; they pay carpenters, loaders, contractors, scaffolding guys in cash. Will that come to a standstill?

A: It won’t come to a standstill, but it slow it will impact for the first 3-4 months for sure. Even consumption will slow down. We are already hearing that restaurant billings have gone down, mall visits have gone down, hotels are down, airline tickets are not being sold - - so there will be some impact, because people are still finding their feet around and how to convert black into white or how to organise their lives, so I would guess it will impact one quarter for sure, but I think you have to go through this pain, you have to go through this hardship for future.

I think it is a game changer. We are one of the countries with a largest amount of unaccounted money and it is menace, it is a disease we have and in one short we are able to remove last 5-6 decades of accumulation and conversion of black money.

Q: The real estate sector by when do you think it might start seeing reasonable improvement in sales. It is going to decline, but decline till the next 6 months, next one year?

A: I would say even a quarter, because you see the demand is insatiable for homes, availability of the right size of flats are not there and initially there will be some big advertisements in newspapers in the last two weeks, the feedback I got from developers is there is no enquiry. One developer put many ads in the newspaper and television he expected 100 sales, 100 flats to be sold in the first inaugural time and they only sold 15-20.

It is going to take time, because people are still worried about money at home, money given to someone, how do we get legal tender back.

Q: That is for now and even conspicuous consumption, part of it was probably happening on unaccounted money, so that consumption goes down as you pointed airlines and jewellery, but here it is a whole economy, it is not consumption only. Do you fear for instance now even for HDFC, but more so for smaller finance companies that people are not able to pay EMIs, because a lot of people have lost jobs - - cement, construction, contractors do you fear it can go that bad?

A: I don’t know I don’t fear that, I don’t fear people are losing jobs because of demonetisation at all. Even in real estate they are not going to lose jobs, because the demand is there, half constructed buildings are they have to complete. It is a question of money the cash which is not there, how do they raise cash, if some developers have borrowing capacity they will borrow, but if they don’t have they will have to sell existing land, they have to sell some floor space index (FSI), they will have to bring a partner in or they will have to reduce the price of lands. They have no other options and therefore I am confident that some prices will come down more in the secondary sale.

Q: But what is your sense 40 percent, 30 percent when should we think that a correction a reset is over?

A: See you can’t generalise across the board. I think high-end flats will probably fall more. Affordable flat may not fall because they are anyway Rs 10-15 lakh and so it is a mixture of 10-25 percent or so.

Q: Do you expect knock on impact on cement, on paints and sectors like that?

A: Not at all. One quarter yes. One quarter certainly, because it will be slowdown and they have to readjust their books, their accounts, their method of working they have to do all that because there is lot of cash in the system. As I said, 70 percent of the value of transaction in India are done by cash and this is very good for the debit card, the credit card, the Paytm and we have to move towards a cashless society and again another reason for demonetisation let’s move towards the cashless society. We are still a very much a cash society, that way I think I cannot find a single fault and people are saying execution could have been better, but this has to be remain a secret. Very few people knew about it. There have not a whisper. We all came as a total surprise, so you had to and ATM like we have 12,000 ATMs. Rs 2,000 note we have to recalibrate the ATM machines. Every ATM doesn’t need Rs 2,000 but the city ones, big metro ones we need to recalibrate and we don’t have enough engineers to do that. It take 200-250 ATMs a day so it is going to take a week or two weeks to get all our ATMs recalibrated. It is the same problem with other bank.

Q: That is the initial teething problem which will sort out. Yesterday Mrs Bhattacharya was speaking with us and she thinks November 30 is a very long date, she was expecting it even earlier. She thinks the worst is over, but my point is more in terms of the economy pain. We are still every quarter asking the banks have NPAs peaked out, have you flushed out the worst. Now comes another series of pain probably for MSMEs, SMEs, real estate, cement, allied sectors. So, do you think this economy which we thought will trough out and grow this year is going to take a year or two to grow?

A: The GDP growth rate may come down a bit but I don\\'t think it is going to impact us for a year or two. For 2016-17 we should expect for the next two quarters at least the last quarter in their calendar year and in the first quarter next calendar year to be impacted where turnover will be down, sales will be down therefore profits will be down and the growth will be slow but it will come back normally. See, today people are just putting money in the bank. As I mentioned they have not taken money out yet because you are not allowed to take money out to buy also.

Q: There is withdrawal limits.

A: Yes, withdrawal limits are there. So, let those withdrawal limits be relaxed over a period of time and then you will see consumption coming back. But it is a step we have taken, the government has taken knowingly that it will impact the economy for one or two quarters, but next year will be better then.

Q: Even before the demonetisation we saw some builders almost at bankruptcy level having declared bankruptcy, do you think more such instances will be heard of builders, companies going bankrupt?

A: You may hear a few, certainly you may hear a few but where land is a value and most of them have land, they go bankrupt because they over borrow and they have bought land. Land has definitely some value, it may not have value today, it may be of value ten years later or five years later. So, they will be able to monetise some amount of their money by selling land at a cheaper price.

Q: But a couple of things happening in the interest rate market as well. We have seen inflation rate coming down even before demonetisation. Now with the demand from black money going down definitely people will recalibrate inflation rate and then of course with so much deposits, bond yields are also coming down what is your sense about the cost of money? One quarter down the line, two quarters down the line would you say the borrowing rates will be one percent points lower?

A: I am confident that in the next six months at least till March the borrowing rates will be about three fourth or one percent lower. Half to one percent lower in the next six months till March, may not be in December, maybe early next year but there will be one or two small half a percent or quarter percent of rate cuts because another reason is the government also is keen to start kicking the economy, how do we restart the economy which has been halted by this big move. So we have to bring it back to the level. So, they will be forced to reduce rates and inflation is coming down, there is no reason why and the banks are sitting with surplus money.

Q: You are a close watcher of stock markets as well. It is one part of the financial market. What is the sense you are getting, you have seen some fairly steep falls, but we are coming close to the Trump day low of 8,002 we didn't quite get there but do you think we are going to see more falls before confidence comes back, earnings downgrade, GDP downgrade are just not yet in?

A: I have not seen India in a stronger position that I see it today in all my 45 years. So, this is irrational why our stock market is reacting to Trump victory or reacting to demonetisation because the monsoons have been excellent, the oil price is stable and even the Organization of the Petroleum Exporting Countries (OPEC) countries are saying it will remain like this in 2020 under USD 60. So, we are in a strong position today and over reaction of Trump victory that he is going to start doing tomorrow and which is going to impact IT industry overreacting on the demonetisation that NBFC are killed and microfinance have gone 30-40 percent down NBFCs, housing finance business will disappear is all wrong. Wrong as the mess is overreaction, I am not at all worried about HDFC at all. I am sure the growth will be reasonable this quarter. It won't be negative, it will definitely be positive. I have not seen a slowdown in a number of applications, at least so far. So, I don't see, it is a little overreaction.

Q: The reaction is because of this big fear that a lot of loans have been given against property. How much of the NBFC or housing finance sector separately, are loans against property?

A: I have always maintained that loans against property is the probably most dangerous item on a balance sheet compared to new loans for a new flat because most of the people who buy new apartments or a secondary apartments or staying in themselves, so there is no problem there and anywhere so far as we are concerned our loan to value at origination is only 65 percent, so we don\\'t have a problem.

Loans against property if the business comes down, or if the cash flow disappears many people have cash income. If that flows are down or if that dries up then there could be a problem and NBFCs will now be more cautious in lending loans against property.

Q: What is loans against property (LAP), is it 30 percent you think, NBFC?

A: Some NBFCs have even 90 percent of their portfolio LAP and it is 30 -50 percent. We have under five percent in our portfolio and we are very careful about it. So, I am not worried about it but there have been a couple of analysts who have written papers on LAP because LAP means in the FII lingo it means home equity loan. What impacted the US real estate market was the home equity loan.

Q: This is our sub-prime concept?

A: Yes, sub-prime concept.

Q: Do you think that therefore if someone is buying a home it is better to buy it after a year?

A: It is more need based, things are not going to change drastically. Maybe marginally 5-10 percent comes down but this is the time to go with the cheque payment to the builders and say I am willing to book today, give me a discount. He needs money, he will sell it off at a lower price.

Q: But you should buy off -the-shelf and not under construction?

A: No, off-the-shelf or under construction but decent builders will complete it. You may have to wait six more months or a year more but there are enough number of decent builders who have never not given a delivery.

First Published on Nov 16, 2016 05:18 pm