Would you buy the apartment that sets you back Rs20,000 every month in rent for Rs1 crore? You might if the flat were appreciating 15% a year; you earn Rs25 lakh a year; have Rs20 lakh in the bank; and the interest rate on the Rs80 lakh loan were 10% a year. The incentive to buy drops off appreciably as the interest rate on the home loan climbs. And if more people choose to live on rent rather than buy houses, residential property prices cool, although rents start climbing. When interest eats up all the gains from rising house prices, the decision to buy is dictated more by lifestyle than economics. This is broadly what the Reserve Bank of India hopes to achieve by raising interest rates 10 times in the last 15 months. Real estate bubbles are among the first targets for central banks trying to battle inflation.
Bank lending to new homeowners grew 15% last year, while their loans to builders climbed 21.4%. These are roughly in line with the 20.6% growth in credit to the non-farm economy in 2010-11. The central bank wants to put the squeeze on lending for housing, and it is eminently capable of doing this because banks have become intrinsic players in the Indian urban property market. Banks put up Rs4 for every Rs1 that most urban buyers bring to the table when they purchase a house. Similarly, they lend builders 60% of the cost of developing real estate. Typically a bank has a Rs1 crore exposure to the Rs1 crore apartment that you may be thinking of buying: Rs80 lakh as a loan to you and another Rs20 lakh loan to the builder who is selling it at a 10% mark-up. By raising interest rates and the money that banks need to keep aside for real estate lending, the central bank has a grip on both the demand and supply feeding the bubble.
All this, of course, hurts the bloke looking to buy a house in, say, Aurangabad, where prices are not in as much a tear as they are in the big cities. He, and the hapless end-user in the metros, pays the price for excessive speculation in select pockets. The black money chasing Indian housing compounds the problem, taking it beyond the realm of textbook policy suggestions. If half the price of a house is transacted in cash, the central bank can compress demand only up to a point. The Reserve Bank has been consistent in its zeal to prick housing bubbles, but it cannot be left alone to do so. The government must chip in by flushing black money out of the walls we live within.