If capitalism has to work in developing economies, including India, it has to become more inclusive, it has to understand and deliver property rights to more people. That’s what Peruvian economist Hernando de Soto, adviser to 40 governments, told me last week as we discussed the future of capitalism in India. For this, he said, governments need to first study the laws that govern property rights and then change them so as to reflect their country-specific realities. The conversion of squatter rights to legal ones, for instance.
His argument, that that has been the case across the world and one that must be implemented sooner rather than later as the developing world, including China and India, joins the universal globalisation phenomenon, is compelling. Only a small percentage of people, around 20 per cent, in developing economies (no data available for India yet) practically function under the western system of legal rights, he said. The rest of the population functions like the way people in the US and Europe used to, as close as just hundred years ago, with informal or non-legal systems of rights.
But implementing and delivering clean property titles to the poor is a far cry, a very long-term idea that will get no political hearing today, particularly in a fractured polity like India’s. The task gets further complicated when nine out of India’s 10 land titles are under legal dispute in one form or another, as a McKinsey report notes. Take de Soto’s theory a little further and you’ll probably reach a conclusion that like the sub-head of his 2000 book The Mystery of Capital, capitalism may not be able to triumph in India. While the dreamer in me disagrees, my pragmatic side tells me that in some states the bridge towards that triumph is being built in the form of lower stamp duties.
A quick look at another sector shows the positive results of lower transaction costs, unarguably one of the first steps towards efficiency and inclusion. I’m talking about the impact that finance, markets and lower transaction costs, when replicated in the property market, can deliver. As brokerage rates on share transactions fell by 92 per cent, from 2.5 per cent in 1992 to 20 basis points (that’s 0.20 per cent) today, turnover in the cash segment of the Bombay Stock Exchange rose from Rs 45,696 core to Rs 816,074 crore in 2006 (almost an 18-fold jump), the number of trades rose 20 times to over 260 million, and the average trade size rose 8.5 times to Rs 30,911.
This model needs to be urgently cut-pasted on property markets through lowering of stamp duties. Among others, the Delhi government is doing very well on this front. Stamp duties in the city, which had been steady at 8 per cent between financial year (FY) 1981 and FY 2001 jumped 5 percentage points to 13 per cent in FY 2002. In FY 2004, the government brought it back to 8 per cent. The result: between 2003 and 2007, the government’s receipts from stamp duties rose from Rs 382 crore or 6 per cent of total receipts to Rs 850 crore or 8 per cent of total receipts. If the Rs 1,350 crore target (10 per cent of total receipts) for FY 2008 is reached, the state would have seen receipts from stamp duties grow at a compounded rate of almost 30 per cent per annum — almost as fast as corporate India’s net profits.
Other states are learning too. West Bengal, for instance, was an early starter, when in FY 1995, it cut a six-year outrageous 21.2 per cent rate to 14 per cent and then, two years later to 8 per cent. Uttar Pradesh reversed a 10-year 14.5 per cent rate to 10 per cent in FY 1999. On the other hand, Madhya Pradesh, which raised rates from 2 per cent to 11.5 per cent in FY 1980 and Gujarat, which raised rates from 5 per cent to 7.5 per cent in FY 1983 and then further to 10 per cent in FY 2001 are the laggards in the rather painful history of stamp duties in India.
Going forward, the Delhi government plans to reduce it further — the state cabinet has approved a fall to 6 per cent for men and 4 per cent for women — which is good news for all stakeholders: households, the real estate and construction industry and the government. By lowering rates, the incentive to dupe the exchequer of legitimate taxes falls. The average black or unaccounted cash component in Delhi, at between 40 and 60 per cent, remains high, but it’s early days. Marry this fall in stamp duty rates with the way the Central government is trying to plug every possible loophole on the spending side, and the future of unaccounted wealth moves from black to bleak. Scholars have argued that state governments could double their stamp duty receipts if properties were valued correctly.
But like a chicken-and-egg syndrome, I don’t think that’s likely to happen unless, ceteris paribus, stamp duties fall like they have in Delhi, West Bengal and Uttar Pradesh. If stamp duties are looked upon as a service delivered to households to enable their most expensive transaction, which in turn facilitates wealth creation through credit availability and new instruments like reverse mortgages, it should, like brokerage rates in securities transactions, be brought down to levels that match the scale and velocity of such contracts, the net result of which could well be a 1.3 per cent addition to the GDP growth rate, according to McKinsey.
Of course, all these issues — de Soto’s legal, finance ministers’ fiscal, market participants’ transactional, policymakers’ economic, home ministers’ social — need to be resolved simultaneously. But until politics finds a way to work on the rest, let’s learn from the markets and rewrite the transaction cost numbers. If the rising Sensex is a manifestation of lakhs of investor inclusion due to lower costs, it’s about time we replicated the inclusion model for crores of households in property markets and reduced the friction to mass wealth creation. The National Housing and Habitat Policy’s recommended rate: 2-3 per cent; mine: less than 1 per cent; let the debate — and wealth creation — begin.
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