Indian economy: will the stimuli work?

The global financial market meltdown and its effect on the Indian economy has forced the Reserve Bank of India and the government to initiate some more measures for uplifting the sagging economy. Let us examine the details of the ‘stimuli” and its possible effect on the housing sector.

The main accent of the RBI’s stimuli is on interest rates. The government’s package is a mixed bag — additional budgetary expenditure of Rs. 20,000 crore, tax/duty cuts and increased lending by public sector banks.

The major policy announcements by the Reserve Bank made on December 6 are:

Reduction in repo rate to 6.5 per cent and reverse repo to 5 per cent

Housing loans up to Rs. 20 lakh to be treated as ‘priority sector’ lending

Refinance of Rs. 4,000 crore ( details to be announced after the meeting of RBI Board, slated for the current week), for the National Housing Bank for financing construction/purchase of dwelling houses under the priority sector to individuals/families

Five per cent ceiling on housing sector priority quota within the overall priority sector lending; such loans sanctioned up to March 31, 2010

Concessional treatment to commercial real estate lending and consumer loans extended up to 30-6-2009.
Interest reduction war?

Even before we read the news item in the morning papers, the television channels beamed the decision of ICICI Bank to reduce interest on home loans to 11.5 per cent from 13 per cent, a hefty reduction of 1.5, on housing loans up to Rs. 20 lakh. While the general public may be carried away by this high speed action, since the ongoing interest rate movements are a by-product of the ‘stimuli’ to the sagging fortunes of the Indian economy as a result of the global meltdown, other steps are necessary as a follow-up measure.

The government came out with a package of economic revival ‘stimuli’ on December 7, which has certain direct and indirect measures to support the real estate sector, such as

Housing loans up to Rs. 5 lakh to be treated on special footing.

Loans above Rs. 5 lakh and up to Rs. 20 lakh to be treated as priority at concessional rate.

CENVAT relief of four per cent for all dutiable items.

Special approach to residential housing segment.

Why the reduction in rate only to loans up to Rs. 20 lakh?

The specific plan behind the RBI’s declaration of housing loans up to Rs. 20 lakh as ‘priority’ sector is not very clear. However, this only prompted the ICICI to pass on the repo rate reduction to lower and middle class investors who are shying away from investing due to high prices.

Interest on home loans during the last two years.

The home loan rates climbed from around nine per cent to about 14 per cent during the last couple of years. This, along with the increasing cost of construction materials, service charges, cost of stamp duty and registration charges, enhanced the cost of investment in the housing sector by 20-25 per cent. Coupled with the general rise in land cost, this increase has discouraged investors, especially the lower and middle class. Promoters and builders who had big plans for expansion have deferred their plans to invest in new ventures. As a result, the housing market has been dull and demand has came down by almost 25 to 30 per cent, according to top builders.
Cheap money policy

The urgency shown by the RBI and the open direction from the former Finance Minister last month will certainly encourage banks to pass on the reduction in their cost of funds to the borrowers in general and to the small investors in real estate. However, not extending the reduced rate to all the existing borrowers may have negative effect. Most of these loanees may opt to change over to other banks. Another possible effect can be the borrowers utilising the opportunity to limit their borrowing to the upper limit of Rs. 20 lakh in order to get the benefit of lower interest. Yet, the idea needs to be welcomed.

Major effects on the sector can be:

Fillip to long term lending, say 25-30 years.

Preference to floating rates.

Relocation from congested cities to less crowded towns.

Movement from central districts to outskirts.

Green structures to counter climate changes.

Development of townships in and around metro rail terminals.
Cautious approach

Another point to be debated is whether all banks will be in a position to reduce interest on lending unless their cost and asset liability match. Despite positives, it is better to wait and watch for a while. In case the recession is to continue for a while, say 2-3 years, the money value can come down substantially. Optimism pays, but caution can be the watchword. If interest rates go down continuously, the benefits should be fully availed by the borrowers, as the up-cycle will come, may be a tad late in the day! The good news, however, is the positive responses from many banks such as BOB, BOI and Oriental to reduce the rates.