RBI's second quarter review of Monetary Policy: A big hit on the Reality Sector?
RBI released its second quarter review of monetary policy on 2nd Nov 2010. Most of the changes announced were in line with the market expectations. Both the Repo rate and reverse rate were hiked by 25 basis points, raising repo rate to 6.25 %, and reverse repo rate to 5.25 %. The CRR rate was left unchanged.
The changes were introduced with an aim to curb the inflation and asset price increase. The food price inflation has touched 13.75 % that has been a cause of concern for policy makers. On the manufacturing side, the inflation has been on constant rise driven by both supply and demand factors. In addition, the commercial bank credit has increased to 83 % against 35 % last year. This has created credit crunch in the money market. The rise in repo rate and reverse repo rate is expected to rein in the demand for credit. The decreased demand of credit will affect the demand side of the inflation thereby containing the inflation.
RBI also announced major policy changes with respect to real estate sector. Real estate sector has recovered very well from the low of last economic recession. In some markets such as Mumbai, the prices have doubled in last one year for some major projects. This might lead to another asset price bubble in the real estate sector. To counter this, RBI has announced some measures in context of lending to this sector. It has reduced loan to value ratio for house loans at 80%. Additionally, standard asset provisioning for teaser home loan rates has been hiked to 2% from 0.4 %. RBI has also proposed to increase the risk weights for residential housing loans of Rs 75 lakhs and above to 125 % irrespective of its LTV levels.
The measures introduced by RBI are going to have both direct and indirect impact on the fortune of the real estate sector. Teaser home loan rates have been under constant scanner of RBI. Under teaser home loan, a mortgage loan is charged very low interest rate in the initial years. However, after 2-3 years, the rates are linked to floating home loan rates that are in most cases higher than the low interest rates in the starting years. Owning a house has been the dream of middle class all over the world, and Indian middle class is no different. In its pursuit of this dream, an individual might be enticed by low rates offered in initial years under teaser home loans. He might not carry due diligence on what will be the rates after initial years and if the rates rise, such individuals might default which might lead to subprime like crisis. RBI wants to avoid such situation, and has thus increased the capital provisioning (by banks) for teaser home loan rates. This is going to affect the demand in real estate at least in short term. Nearly 20-25% of banks' outstanding housing loan portfolio of around INR 3.4 trillion is linked to teaser rates as on 30 September, according to rating agency Crisil Ltd. The increase in asset provisioning will put brakes on the use of such teaser home loans. Thus, residential buyers will have to borrow money at higher rates under normal home loan schemes. The increased rates will mean lower number of people buying houses. However, in the long term, this is going to protect the residential buyers from unanticipated increase in interest rates.
RBI has capped the loan to value (LTV) ratio for home loans at 80%. Some of the Indian banks such as ICICI have disbursed home loans up to 90% of the value. Thus, home buyers will be able to borrow lesser amount in the new policy regime. This will decrease the demand for residential real estate. However, this might have an indirect positive effect on the dynamics of real estate sector. Most of the houses are registered at prices lower than their true value because of high stamp duty. Now since LTV has been reduced to 80%, there will be a lesser tendency to register houses at lower values. Higher registered value will enable a residential buyer to borrow extra money from the banks (as compared to the case when houses were registered underpriced). This will increase the tax collection for real estate. Along with the rationalisation in the stamp duty, this policy change will reduce the amount of black money flowing to real estate.
Finally RBI has increased the risk weights for home loans of INR 75 lakhs and above to 125 %. Thus, banks will have to allocate extra capital for such high loans, and thus will have lesser inclination to finance such loans. This is surely going to impact the premium segment where prices are in the range of INR 1 crore and above. Indiabulls Real Estate and HDIL will be severely affected since they have high exposure to premium segment. Overall, this measure will have very less impact on the fortune of real estate sector. This is because more than two-third of the demand in real estate sector is from affordable segment where houses are priced below INR 30 lakhs.
Overall, we can say that the policy announcements made by RBI will have a neutral effect in the short run. But in the long run, it is going to have positive impact in terms of protection provided to borrowers (in form of brakes on teaser home loan rates), and in terms of registration of houses at their actual value.
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