Major impediments to Infrastructure Development in the Country
• Financing
• Land Acquisition
• Regulatory Framework
• Delay in Clearances & Implementation
• Slack capacity
• Uneven private participation
• Governance related constraints
• Efficient pricing of infrastructure
Over the short-term however, poor economic activity and elevated levels in interest rates are curbing the residential and non-residential building activity. In October and November 2013, the Reserve Bank of India (RBI) hiked the benchmark interest rate by 50 basis points (bps) to 7.75%, increasing the cost of capital in India to a relatively high level. Given the lagged impact of monetary tightening, this means that the negative implications with regards to credit uptake could persist through H114 and deter construction companies from taking on new projects and households from taking on new mortgage loans.
In addition, the Indian rupee remains very weak and is once again on a depreciatory trend. Since the start of October 2013, the rupee has fallen by about 3% against the US dollar to reach around INR64.00/US$ at the time of writing. This could dampen non-residential building activity. This is because it would make it more costly for Indian infrastructure companies to purchase overseas equipment and raw materials as well as repay their overseas debt borrowings. Foreign construction companies may also be dissuaded from taking on projects in India due to concerns over the final value of repatriated returns from their investments.
We do highlight that real estate developers would be less affected by the weaker rupee as they require fewer inputs from overseas markets due to a lower need for technologically sophisticated equipment (such as steam turbines). A weaker rupee could also boost the demand for speculative assets such as housing from overseas investors.
Business Environment Puts Ceiling On Growth
The increasing cost of high-quality housing in major cities such as Bangalore and Chennai should work to incentive developers to build over the long run, yet institutional, political and environmental bottlenecks continue to limit the project pipeline. Furthermore, high prices will discourage the development of a thriving middle class market over the medium term, in the absence of a significant increase in new stock.
Crucially, we highlight that the residential sub-sector will provide the greatest potential in the coming years. A relative surplus of commercial real estate is exacerbated by a slight slowdown in India's export sector, which has occurred due to weakening global activity.
However, India's fundamentals will continue to exhibit monumental long-term growth potential. We are witnessing strong demand across the board, and expect second- and third-tier cities to add to their housing stock in line with improvements in national and regional infrastructure.
We attribute this to promising developments that signify an improvement in India's regulatory and financing environment. There are currently plans to launch a new land acquisition bill, which would unblock bottlenecks constricting the flow of public-private partnerships (PPPs). Although we are still bearish on the issue, the law would provide significant impetus to India's private land market. A government proposals states that the government acquires land for PPP or private projects for public purposes if gaining two-thirds consent from those losing the land, whilst Sonia Gandhi is pushing for a higher threshold of 80%. Although we believe that the latest version of the land bill is not exactly favourable to investors - we expect them to pay twice market value for urban land and six times for rural development - it would at least provide greater clarity and speed up the currently convoluted land acquisition process.
India also has plans to pass the Real Estate (Regulation and Development) Bill in the parliament's monsoon session (July-September) in 2013. The bill aims to create a uniform regulatory framework for the residential sector and to enforce it through the creation of a central regulatory authority and various state levels authorities. According to the Times Of India, the bill seeks to prevent developers from putting out misleading advertisements; ensure that they don't market projects unless necessary approvals are in place; and direct developers to declare a time frame for developing projects. The bill also seeks to impose monetary penalties on the developer for project delays, with repeat offences liable for a jail term.
Developers are also required to keep 70% of the funds realised from sales of a project in an account for construction expenses. This prevents them from using the funds for other projects and delaying the first project.
If implemented, the bill could resolve several structural weaknesses in the investment climate for the residential sector. For example, real estate projects have long implementation periods due partially to the need for numerous approvals. According to the Builders' Association of India, a housing project typically needs more than 55 approvals from various local, state and central government bodies and they take a minimum of 15-24 months to be completed.
There is a growing number of construction machinery manufacturers entering India in H212. Chinese construction equipment producer Zoomlion Heavy Industries announced in August 2012 that it was to set up a joint venture (JV) with ElectroMech, India's largest industrial crane maker. The news reflects a relative slump in the firm's performance in its domestic market. Furthermore, established industry players are upping capital expenditure (capex) outlays, with market leader JCB announcing the establishment of their fourth manufacturing plantat a 70-acre site in Jaipur, at a cost of US$92mn.
One important aspect of growth has been highlighted by our country risk team. Due to the increasing autonomy of state-level economic policy, coupled with the widening disparities in regional business environments, it is more important than ever to take a sub-national view on investment opportunities in India. Vastly different infrastructure endowments and the likelihood of an increasing divergence in regional policies will see domestic and external investment flows impact differently, depending on the state in question.
It is our view that current GDP per capita will have little effect on industry growth prospects - we see poverty stricken Bihar as the current outperformer as reforms allow the state to rapidly converge, yet also see wealthy Gujarat performing well. With this in mind, we note that there is plenty of scope for a diversification of foreign direct investment flows away from the traditional hotspots of Mumbai and New Delhi. Most importantly, we believe that states with smaller governments - Gujarat, Haryana and Maharashtra- will perform better than others, as increasing liberalisation and a reduction of red tape will allow the non-residential sector - retail, commercial and leisure builds - to expand.
The Indian government's approval of foreign investment into multibrand retail has been dominating the domestic headlines. On July 16 2013, a meeting of senior cabinet ministers approved a series of steps to further liberalise India's foreign investment regulations. As seen in the accompanying table, the government has relaxed investment rules on a handful of major industries via a mixture of increases in foreign investment caps and the removal of the requirement to seek government approval.
Some of the major initiatives are the increase in the foreign direct investment (FDI) cap in the telecoms sector to 100% from 74% previously, as well as the cabinet's decision that investment up to 49% in the single-brand retail sector will no longer require the Foreign Investment Promotion Board (FIPB)'s approval. As such, global majors such as Walmart, Tesco and Carrefour would be allowed to sell directly to the Indian consumer for the first time, in what would likely trigger a major shake-up of the country's retail sector, providing a boon to the industry as traditional markets are subsumed by malls and outlet stores.