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What the home loan rate cut plan lacks

BS Bureau | December 18, 2008

Following up on the government's fiscal policy package announced a few days ago, public sector banks came up with their contribution earlier this week in the form of lower interest rates for small housing loans.

Borrowers up to Rs 5 lakh (Rs 500,000) will now be charged 8.5 per cent per year, while those taking between Rs 5 lakh and Rs 20 lakh (Rs 2 million) will pay a slightly higher rate of 9.25 per cent.

These rates will come with a lock-in period of five years, after which the borrowers will have the choice of shifting to either fixed or floating rates prevailing then.

Of course, these rates are not available to existing borrowers looking to refinance their loans at better terms, since the whole objective of the exercise is to stimulate new demand for housing, which will then provide a boost to the construction sector and, through its multiple linkages, to the broader economy.

These measures bring the effective cost of borrowing down by about 2.5-3 percentage points for eligible borrowers.

Two broad questions arise. The first is whether it is a good idea to force-feed credit in this fashion to one corner of the market, with mandated interest rates that were supposed to have been tossed out a long time ago.

Indeed, bankers have raised questions about how they are supposed to meet costs, because lending at the prescribed rates will mean that they incur a loss.

If one were to set aside these objections, citing the abnormal circumstances of the day, the second question crops up: is this enough to be a significant inducement to home buyers?

The answer must be that, in an environment of rising uncertainty about jobs being retained, there is room for doubt about whether these concessions will do the trick.

The initiative must be evaluated in terms of whether it addresses multiple factors contributing to the sluggishness in the real estate market. Going by price patterns even in these troubled times, the limits on loan sizes appear to be low.

If the borrower puts up the normal 10 or 15 per cent of the purchase price as home equity, the number of properties available at these prices is of course significant -- perhaps as much as 80 per cent of all housing loan accounts fall within the Rs 20 lakh limit.

However, the fraction is much smaller when you look at the proportion of total money loaned out for housing. Apart from which, demand for cheaper homes tends to be in the smaller towns, not in the metros and their suburbs which have most been subjected to the evaporation of demand.

Supply and demand are, therefore, not being brought together. Also, the fact that the real estate development business is funded predominantly by advance sales has led to many projects being stalled as sales have dried up.

Potential buyers, even if they now have access to finance, will be wary of buying properties that run the risk of not being completed within a reasonable time horizon.

These realities suggest that the government needs to do some more to get real estate transactions going. One is to figure out a way to bring prices down to more realistic levels, without crossing into the realm of formal controls.

The other, perhaps more feasible, step is to create confidence amongst potential buyers that projects have reasonable prospects of being completed. One way to do this is to push for consolidation, so that relatively prominent and stable companies, which can be held accountable, take over stuck projects that were promoted by small, fragmented developers.

The real estate sector must accept the inevitability of consolidation. Only developers with a presence in multiple price segments and multiple locations can withstand the kind of shock that the industry has experienced in recent months.

Of course, raising the borrowing limits would also help considerably.



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