Profitable Market Prices Must For Survival


We need to realise the importance of developing the supporting credit markets and transmission mechanisms to boost sectors


Issues that sectors such as residential real estate, credit markets and power generation amongst others have faced in India can be viewed through the lens of the “inability to generate a market-clearing price”. Fundamentally, both price discovery and price transparency for the sectors were lacking, which made it difficult for participants to create an equilibrium around demand and supply. For sure, at a fundamental level, issues such as creating excessive housing inventory, lending excessively to poor credit names and creating infrastructure assets such as power plants that do not have adequate demand are all symbolic of the core issue.

The inability of the ecosystem to signal to the developer, lender and investor that there is lack of fundamental demand for the asset being created and, therefore, the future does not bode well for the asset under consideration is at the heart of the current predicament facing the Indian economy.

Hence, while the real estate bailout fund announced by the finance ministry is a good step within the multi-pronged approach required to resolve the myriad issues around residential real estate in India, a sharp policy focus on ensuring that market-price discovery and transparency improve in the future is critical. Primarily, market-clearing prices that can both clear inventory as well as ensure that excess supply is limited are required. Additionally, it is essential to realise how vital the linkages between the various markets are. The credit quality of the real estate developer, the quality of the actual project that they are developing, the demand-supply dynamics in the local real estate market and the macro-economic factors such as GDP and income growth are all contributing factors.

While issues around macro-factors mentioned above are for the various stakeholders to figure out, we also need to realise the importance of developing the supporting credit markets and transmission mechanisms to boost sectors such as real estate and avoid the current issues in the future. A market mechanism that effectively communicates the gradual inability of a developer to service interest payments on a loan will guarantee that lenders do not continue to lend to such a developer.

And, such a developer will also be less likely to set-up projects where the money from both homebuyers and lenders

such as banks gets stuck. Additional regulations, such as RERA, will ensure that there is more transparency while implementing the various individual projects. The above inter-linkages are an example of the intricacies within the system.

For instance, assuming two similar-sized developers face identical macro-demand for real estate, but one operates in a local market that is more distressed for real estate is a situation in which the market pricing mechanism must be able to price in this piece of information. A gradual decline in the capacity of the developer in the weaker market to service the debt and a fall in asset prices must be relayed to stakeholders to ensure that decisions made by lenders, buyers and other market participants are reflective of the information set available.

While price discovery and transparency are vital components of a well-functioning market, the capacity of market participants to set prices in reaction to demand-supply dynamics is no less so. It is crucial that the government carefully addresses sectors where it has implemented price floors and caps. While in specific areas, such as agriculture, support prices are needed, for others, it is essential to allow the market to set prices. On the other hand, the government must ensure a competitive environment.

For instance, in the healthcare market, if a business is procuring the inputs of production at market rates, then price caps can significantly hamper the long-term financial viability of the sector. Additionally, the classic downward spiral problem may crop up. Price caps lead to financially unviable businesses, thereby creating bad debt and significantly reducing the ability of companies to invest in research and development that results in mediocre products and services for the end-user.

The impact of price caps on sectors through effectively what is “rent-control” can create negative implications as discussed above such that reversing the trends can be an enormous task. Additionally, once industries lose global competitiveness, it is challenging to rejig and revive them. In this connection, issues such as oligopolistic behaviour by firms are of great importance. However, instead of price caps, perhaps institutions such as the Competition Commission of India are better equipped to ensure fair markets.

In summary, India must embrace market prices in generating economic and financial value. Lessons from the past suggest that creating market mechanisms that help direct the flow of capital into productive uses is imperative. IANS