4 More Ways In Which Raghuram Rajan's Credit Policy Has Helped The Real Estate Sector

Reserve Bank Of India (RBI) Governor Raghuram Rajan has slashed the repo rate by 125 basis points (bps) in 2015. Since January, the repo rate, at which the RBI lends to commercial banks, has declined from 8 per cent to 6.75 per cent. Let us take a look at how Raghuram Rajan's credit policy has helped home buyers and real estate in India.

It is commonly know that slashing repo rate would lead to lower interest rates. Since Raghuram Rajan started cutting interest rates, banks have started cutting interest rates too, though the decline in home loan interest rates has not been proportionate. State Bank of India (SBI), for instance, had a base rate of 10 per cent on November 7, 2013. Since then, SBI did not cut the base rate for nearly one and a half years. But, after the RBI cut repo rate twice in 2015, SBI started cutting interest rates too. Now, the base rate of SBI is 9.3 per cent. That is a decline of 70 bps. For instance, till April 7, 2015, at an EMI of Rs 50,000 over a tenure prior of 20 years, a woman home buyer would have been eligible for a home loan of Rs 51.81 lakh from SBI. Now, at the same amount, she would be eligible for a home loan of Rs 54.4 lakh. That is a gain of nearly Rs 2.6 lakh in over five months. But, what are the less direct ways in which Rajan's credit policy over the past two years have helped home buyers?

• Inflation: In August 2015, Consumer Price-based Inflation (CPI) was merely 3.66 per cent. Inflation has rarely been so low in India. In August 2013, before Raghuram Rajan became the RBI governor, inflation was 9.52 per cent. How would this help investors that are keen on buying property in India? At an inflation rate of 9.52 per cent, the value of an apartment worth Rs 50 lakh would double in 7.6 years. But, at an inflation rate of 3.66 per cent, it would take 19.3 years for it to double. This means that home prices would rise slowly in a low inflation economy. Apart from low interest rates, low residential property prices is the most important factor that makes homes affordable.

• Income Levels: For homes to become more affordable, they should be less expensive relative to income. But, income is dependent on productivity, which in turn, depends on the amount of capital invested. For firms to have greater access to capital, interest rates should be genuinely low. This means that the decline in interest rates should reflect fundamental macroeconomic parameters like robustness of the economy and low inflation. As inflation and interest rates have declined, firms have greater access to capital. In the long run, this would raise the income levels of people.

• Investment: Investment in the real estate sector is deeply linked to price fluctuations. For instance, when real estate prices rise in a certain locality, investors assume that this warrants greater investment in real estate in that region. This is because prices rise when there is greater demand for real estate in an area. But, inflation tampers with price signals because price levels generally rise, making it difficult for households and firms to see how much of the price appreciation reflects fundamentals and how much it has to do with inflation. Low inflation in Raghuram Rajan's reign would help the development of well-developed real estate markets in India.

• Real estate prices have much to do with how the infrastructure in an area develops. For development of infrastructure projects and other amenities, low nominal interest rates are essential. Though interest rates have not declined much, it has been falling over the past few months. But, another factor that makes infrastructure projects viable, is the ability of firms to calculate the viability of infrastructure and other projects. To calculate the viability, firms should be in a position to estimate the Net Present Value or NPV (NPV is the difference between the present values of incoming and outgoing cash flows) of projects over the next few decades. But, when inflation is high, it tampers with estimates of NPV over a long time horizon. To estimate the NPVs over decades, stable and low inflation is essential because otherwise firms would find this difficult to predict. Another factor, which would allow development of infrastructure, is the decision of the RBI to allow real estate investment trusts and infrastructure investment trusts to raise funds through masala bonds. A long-term bond market too is essential for long-term infrastructure and real estate projects.