The Hindu Business Line : Of rising rates and shaky foundations

Did the 25-basis-point interest rate revision by the RBI warrant the sharp scaling up of housing loan rates by banks? After dousing inflation, the Government would do well to ensure greater liquidity and smother rising interest rates. Else, the country's aspirations of inclusive development may remain a dream. There is a distinct possibility that a large number of potential borrowers will defer their investment plans, given the growth surges in housing loan rates.

Slowly but relentlessly the floating interest rates for housing loans have soared by close to 200 basis points, from 7.25 per cent a couple of years back to over 9 per cent today.

With the proviso of pegging floating rates to the prime lending rate, most banks and financial institutions have periodically revised interest rates that became painfully evident to millions of customers only on receipt of their annual statement of accounts, or the periodic updates.

There can be no doubt that cheap, and hence attractive, rates for housing loans coupled with handsome tax-breaks drove a growing number of people to take housing loans and accelerated the credit offtake.

In 2003-04, growth in housing loan disbursal was 42 per cent. But by October 2005, the offtake had grown by 125 per cent to Rs 1,53,267 crore.

The National Housing Bank concluded that it was affordability of housing loans that attracted a number of borrowers and swelled the offtake.

Dented growth?

But how far will the emerging trends in housing loan rates dent this growth pattern? By March 2006, housing loan disbursal had fallen to 115 per cent. It would be quite easy and equally simplistic to attribute this fall to increasing interest rates.

However, there are not sufficient correlated figures to warrant such conclusion. But that does not rule out the possibility of such a scenario emerging if firm trends continue in the housing loan market.

Even today there is a distinct possibility that a large number of potential borrowers will defer their investment plans, given the growth surges in housing loan rates.

As most potential customers will be making lifetime investments spanning repayment schedules of 10-20 years, they would rather wait for the interest rate regime to stabilise or soften, rather than take a decision in haste. This would definitely lead to a piling up of the backlog of housing requirements of the country.

As per the Tenth Plan documents, the total number of houses that would be required during the Plan period would be 22.44 million dwelling units, which would require an investment of Rs 4,15,000 crore.

Housing stock

The deficit in housing stock is only part of the problem. Any slow down in house building activities would have a cascading impact on the overall economic development.

Over 250 industries have forward or backward linkages with the housing sector, including such core segments as cement and steel, and economically vibrant paint, ceramic tiles, sanitaryware, plumbing, and electrical units.

If initiatives in housing could generate varied demands and have a multiplier effect on the entire economy, a decline in housing demand could kindle economic recession as well.

Aggressive Banks

There are reasons for concern since several banks have been aggressively pricing their home loan products. While the Reserve Bank of India revised the repo and reverse repo rates by 25 basis points, most banks hiked housing loan rates by 50 basis points and above.

There has been some resistance as a few banks have delayed such announcements, while some have resorted to nominal hikes.

These revisions by themselves may not stymie the potential of the housing sector. But future developments in the interest rate regime could.

As the economy develops, the housing stock is not only viewed as an essential dwelling unit, but more importantly as an investment.

The pattern of viewing dwelling unit as an investment will get further strengthened when functional links are built among savers, home loan borrowers, financiers and capital market investors.

Housing and real-estate are the preferred investment avenues in advanced countries, as they are among the most recession resistant.

Multiplier effect

The multiplier effect of investment in housing in India has grown over the years as housing loans as a percentage of GDP increased from 3.4 per cent in 2001 to 6.1 per cent in 2004. However, tremendous potential remains to be tapped as comparable figures from the UK, the US and the Netherlands are well over 30 per cent. But high investments in housing and real-estate in these countries have taken it beyond the access of common man.

Learning from these experiences, India should adopt a more inclusive housing policy and strive to make housing affordable to larger segment of the population.

Recurrent interest hikes would restrict housing to a select club of relatively richer segment.

But does that mean the demand for housing and housing loans will peter out as interest rates firm up? Not likely since in recent years the sector has been increasingly opening up to Foreign Direct Investments as also to NRIs, Persons of Indian Origin and Overseas Corporate Bodies.

The advent of Real Estate Mutual Fund is expected to heighten this interest further.

Even if the retail interest in housing wanes, the institutional interest could propel it to greater heights. This will not be in the interest of the common man, or the lower-middle-class population.

No doubt, the RBI was forced to revise short-term rates to stem the rising inflationary expectation. But did that nominal 25-basis-point revision warrant a scaling up of housing loan rates by 50 basis points and above?

After dousing inflation, the Government should strive to ensure greater liquidity and smother rising interest rates in the ensuing Monetary Policy Reviews.

Else, the country's aspirations of inclusive development may remain a distant dream.

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