Cut in Interest Rate by RBI is a boon or a bane to real estate? – LJH

Bengaluru, November 24, 2015: Earlier this year, when RBI reduced the repo rate drastically, lowest since 2011, it was a cause for celebration. Going back to basics, understanding what reduction repo rate means for the economy is a necessity.

Definition

A rate cut by the RBI means a reduction in either the repo – the rate at which banks in India borrow from the central bank, or the reverse repo – the rate at which banks park their funds with the RBI.

Facts

Scenario

When the repo rate is cut by the RBI to boost the economy, there will be more liquidity and availability of funds at a cheaper cost.With the cut in repo rate, the banks first step is to cut its interest rate payable to its customers on deposits.To fulfill the above scenario the banks have to reduce their lending rates (loan interest).

Currently, transmission of monetary policy has been an issue with the central bank. RBI has reduced the policy rate by a total of 125 bps during 2015 till date but banks’ base rate cut has been no more than 40-50 bps in the period. The Reserve Bank is not comfortable with the fact that commercial banks are not passing the entire benefit of base rate cut to the new customers.

Inference

The reduction in CRR or Cash Reserve Ratio is likely to improve the availability of funds bringing in more liquidity to the system. The interest rate over various loans provided by banks would lower provided, banks change the policy willingly.

An interest rate cut will affect the common man depending upon the type of home loan that the existing borrower has taken. And if one is looking to take a home loan then interest rates will be an important factor to consider. The two types of home loans namely floating rate loans and fixed rate loans decides upon the interest payout and the tenure on such loans in a rate cut scenario.

Obstruction

With a limited 50 bps cut in loan interest rate the actual benefit of repo rate cut is not reaching the final consumer or the person availing loan. The interest rate should fall further to attract the consumers to avail more loans.

With a steep drop in interest rate, consumers can save a lot of money (Interest payable) or the tenure to repay the loan, but the banks are not reducing the interest rate in spite of continued pressure from RBI as well as the government due to their ever increasing rate of NPA.

NPA or non-performing assets is a debt obligation where the borrower has not paid any previously agreed upon interest and principal repayments to the designated lender for an extended period of time. The non-performing asset is therefore not yielding any income to the lender in the form of principal and interest payments.

This process involves the banks deciding on its base rate keeping in mind its NPA. The banks do not want to compromise on its spread (margins) by reducing its interest rate to the limit of repo rate cut and incur more losses.At this point of time the government as well as the RBI is expecting more cuts in interest rates to make loans attractive.

Real Estate

With soaring prices of real estate in India and high interest rates offered by banks, the demand of real estate is sluggish. The unsold inventory is piling up.Since there is a positive wave in the market with interest rate cut by banks up to 50 bps and with the markets anticipation of further rate cut by banks, the demand for real estate could be boosted.

The real estate sector might see higher demand when interest rates are cut. Apart from the lower cost of borrowing, a revival in a number of other rate-sensitive sectors and higher employment also spurs demand for the real estate sector. A pick up in the economic activity and job creation result in higher demand for housing.

When interest rates on bank loans come down, more people will avail such loans to buy assets including real estate. The up-tick in the market continues until the seemingly ever-growing demand for land and housing causes atremendous rise in price to a point of having no takers.

Lower interest rates are of little help to people who do not have enough funds to use the opportunity to invest in appreciating assets. A period of lower interest rates is a good time to build a long term investment portfolio.

For the above scenario to come into existence, the developers/builders have to capitalize on the rate cut and come down on their margins. By compromising on their margins the builders/developers might attract buyers and this will help them sell faster.

Takeaway

Since the real estate market has been deteriorating from a long time with falling sales and worsening absorption rate and also the reduction in the number of new launches, the repo rate cut and the lowering of interest rate can be seen as a ray of light to boost sales and to bring up the falling real estate market. This could happen if the banks pass on the benefit they are receiving from the RBI to the final customers as reduction in home loan interest rates.

Now that the banks have started reducing interest rates, it may be time to go for a fixed rate loan as this helps one lock at lower rates. However, one should be cautious of taking a floating rate loan because there are chances of fluctuating interest rates in the future.

We infer, this scenario, today is a bane to real estate market as the interest rate and the repo rate cut is not evenly proportional, resulting in higher market rates and lower demand.

Corporate Comm India(CCI Newswire)