- Risks and opportunities – I
PTI in its manifesto for the General Elections 2018, highlighted that it will take upon itself, and which it has, after coming into power to initiate the effort towards getting built five million houses across the country, over the next five years. An ambitious plan in itself, the Naya Pakistan Housing Scheme was launched by the prime minister– and for this reason will be referred to as PM Housing Scheme (or simply ‘Scheme’ for brevity of word space) — has taken the place of the flagship project of the current government to pull people out of poverty, and those among the vulnerable not far up the poverty line, through getting constructed for them subsidised houses.
The Scheme in itself is a good initiative for supporting the people out of poverty, and for creating economic activity across numerous economic sectors and industry. Yet, all policy is evaluated in the context of international and domestic economic realities, and there are indeed many details to attend to in the case of this Scheme as well. In that sense, there are a number of risks and opportunities involved.
In the Scheme, the government intends to include domestic banks primarily, and also international banks as far as possible, along with giving an opportunity for domestic and international investors to pool in finances through the banking channel; becoming in turn part of the equity holder in this Scheme, earning part of the interest rate in return. At the same time, while there may be some demands by government on those future house owners who can fund some part of the mortgage — a kind of loan that is secured by the commitment that in case faces default on interest payments, the amount of principal will be recovered by the involved bank, through either the sale of the house itself to whatever extent it stood completed and the land on which it is built, and for this availability of security, the mortgage is provided at a far lower interest rate than on an unsecured loan — basically the government will provide the entire value for loan in the shape of land, on which the house needs to be built.
Moreover, the interest rate will have to be paid by the future owner himself, and could if wanted select a repayment mechanism whereby in the scheduled interest payments stand included paying a part of principal, so that at the time of maturity of the mortgage, both the principal and interest stood paid. Yet, it would mean paying a relatively heavier amount on every scheduled payment. Also, another matter of decision for a future house owner (or simply, ‘owner’) is whether he is paying a fixed or a variable interest rate over the payment horizon; something which the government will have to involve itself with the banks and the owners; where different households depending on their economic status would like to opt for a different mode.
Also, as to whether the bank or the owner will pay the transaction costs related fees, will have to be decided beforehand
Here, there appears to be a difficult situation the government would find heading towards — that is if the interest rate is variable, and the fact that the government intends to pursue a programme with IMF, which would look to increase policy rate to curtail inflationary pressure that is building, and the forecast is that it will continue to build over the short to medium term given primarily the cut in global oil supply from Iran at the back of US sanctions, would overall mean that the repayments will be heavier over the repayment horizon.
Also, there seems to be an intrinsic contradiction in government’s economic policy where on one side it wishes to pursue a contractionary monetary policy in an IMF programme, to curtail aggregate demand to rein in on rising fiscal and current account deficits, and on the other hand is providing a huge fiscal stimulus to the economy in the shape of this Scheme, which will enhance aggregate demand. At the same time, given the contractionary monetary policy being pursued, will result in less output, less employment, less savings overall, in turn with diminishing savings for housing sector in this environment, impacting negatively the pool of loanable resources. Already, the forecast on economic growth rates being kept at a little less than five percent, both from the side of government authorities and multilateral agencies, which according to independent economists will make it difficult to create enough savings for this Scheme.
What this would also likely cause banks to internalise, is to offer variable interest rate plan to the owners, which would add greater worry for the government that these low-end owners in terms of income scale, may not be able to pay for likely rising interest payments situation at the back of rising inflation rate risks — especially because of the lukewarm impact of policy due to the competing signals and little diminished strength of aggregate demand — that would put pressure on hiking up policy rate, which will ultimately push up mortgage rates. Another problem on the repayment side that would surface as a consequence, would be that banks knowing about the low financial capacity to repay by owners, which mostly those are on the low-end income scale and hence the need for subsidised houses in the first place, and would therefore enhance built-in value of ‘risk premium’ in the overall mortgage rate, which will rise as a result.
Given the high level of information asymmetry that has been kept by banks in any loan plan — at the back of better regulation wanting from Sate (or Central) Bank over the years, which could take some insight from the ways in which Indian central bank has made a crackdown on banks there recently, and the highly risk averse nature of banks to have been primarily investing in T-bills instead of providing more credit for private sector — the government will have to ensure with the banks that all information with regard to the repayments are made transparent to the owner, and including the amount of penalty for missing one or more scheduled interest payments.
Also, as to whether the bank or the owner will pay the transaction costs related fees, will have to be decided beforehand; for example in Spain in a recent Supreme Court ruling many of such costs were made a responsibility for the banks to pay. Moreover, the government will have to float fewer T-bills going forward for banks to invest in less, if it wants banks to provide more for mortgage finance and for this will have to plan for raising domestic borrowings from elsewhere. This would not be easy for the government since the high level of fiscal deficit at the back of (a) heavy losses being incurred by the state-owned enterprises, and (b) unclogging demands by energy sector on government finance given the circular debt situation.
To be continued
