RBI’s repo rate hikes – Justified or Anti-Development

Recently, the RBI increased the repo rate for the 13th time signaling what many experts are calling a desperate move to curb inflation. The repo rate is the rate at which banks borrow money from the RBI. The increase in repo rates has been sharp, increasing by 3.5% in the period from 19th March, 2010 to 25th Oct, 2011. As it currently stands, the repo rate has been increased to 8.5% and the reverse repo rate has moved up to 7.5%.The upward movements in the repo and the reverse repo rate have largely been due to the uncomfortable inflation rate level which is hovering above the 9% mark. However many analysts are confused as to how these rate hikes are helping? The previous 12 repo rate increases didn’t manage to reduce the inflationary pressure on the economy. Also this rate hike comes at a period when realty developers are preparing to bounce off a long impending slump in the property markets. This festive season is usually a time when realty developers look to get rid of their pent up inventory. It’s almost always a good season for sales, say developers. However the news looked grim this Diwali period with developers being forced to transfer the fiscal pressure onto home buyers unwittingly. So the big question is are the repo rate increases justified or are they anti-development?

The answer to this question depends on the person being asked. Quite frankly builders are of the view that the rate hikes will weaken the demand for properties further. As it stands, the realty index has fallen by more than 36% since January, a huge slump in sales by any means. To add to the matter property prices have been extremely resilient inspite of the slowdown. In Mumbai prices have actually risen by 10 – 15 per cent.CREDAI president, Mr Lalit Kumar Jain feels that the frequent rate hikes by the RBI will prove to be counterproductive and will have a cost – push impact rather than curbing inflation. MCHI

president Paras Gundecha also echoes similar sentiments. He says that the fresh hike by the RBI will cripple the ailing real estate sector. He might be true; the real estate industry contributes around 6 – 7 % to India’s GDP. In addition it is a growth sector which is highly capital and labour intensive. It is the chief reason for increased FDI in India and also huge employment generation.

While all of the above may hold true for the real estate sector, what cannot be ignored is the risk of rising inflation. The inflation rate has reached such a stage where it has become difficult for policy makers to ignore it. Inflation raises the price of household goods which could silently cripple the whole economy. The projected inflation trajectory indicates that the inflation rate will begin falling in December 2011 and slowly steady to around 7% from there. Governor D. Subbarao also said the likelihood of rate action in December was “relatively low” now, adding that rate action may not be warranted beyond December.Unfortunately this raises more questions than answers. Should monetary policy be used to regulate with an iron fist or should it be refocused towards promoting growth in the different sectors. In any case only time will tell if the policy measures taken by the RBI will yield fruit or not. One thing is clear though the rate hikes will lead to sharp increase in home loan rates putting pressure on home buyers who are already dealing with inflated property prices. Who will relent first, developers, buyers or the RBI?