Will Home Loan Interest Rates Fall?

The interest rate regime in India is caught in an interesting situation where declines in the past six months have brought the interest rates back to the level of six years ago, negating all the advances made in these years. Six years back, major home loan lenders were disbursing loans at 7.5 per cent. That was the time when the Reserve Bank of India's (RBI) key policy rates were low and the system was flushed with comfortable liquidity.

Check April 2009, the RBI's key policy rates and reserve requirements came down to almost the same level as that of 2003, after seeing a spurt in 2006-08. But that did not prevent banks from charging 9-10 per cent on home loans, almost 200 basis points (bps) higher than the 2003 level. So it is important to ask, will the fall stop here or continue further as predicted by many economists and analysts?

Factors contributing to interest rate movements
The current economic crisis impelled the RBI and Central Government to declare various fiscal and monetary policies. The RBI also reduced Cash Reserve Ratio, Repo Rate (the rate at which the RBI lends to banks) and Reverse Repo Rate (the rate at which the RBI borrows from banks) several times, bringing them back to the level of 2003. Various stimulus packages were unveiled to provide a fillip to rate-sensitive sectors. But none of these measures helped revive the economy significantly. Let us look at some of the factors which directly impact interest rate movements:

• As a part of its efforts to mitigate the impact of global economic crisis on our economy, the government pushed the interest rate to an unprecedented low level. But if the rate drops further, to a near-zero level, it would leave little space for monetary policy to operate, rendering it ineffective. So, the interest rate should be posited at a level that will help it absorb a positive as well as an adverse impact.
• Presently, the key interest rates of the US and the UK are 0-0.25% and 0.5% respectively, the lowest in the last 50 years. So, at the current rate India's economy is able to protect the margins or spread, prompting FIIs to invest in Indian markets. Any further downward revision in the rate would be detrimental to the economy as it would lead to the outflow of money from the country.
• Bankers fear that the non-performing assets (NPAs) of banks would go up and credit growth may moderate in 2009-10 in the face of global financial meltdown. So, any further decrease in interest rate might affect their interest margin significantly.
• At this time, the cost of deposits is very high. Therefore, any further reduction in lending rates will directly affect banks' interest margin, ultimately their profitability. Besides, bank fixed deposits are in a direct competition with government-sponsored deposit schemes which are pegged at 8%. It will not be easy for banks to reduce deposit rates as they have to confront the huge difference between consumer price index (CPI) and wholesale price index (WPI). As on June 13, 2009, CPI hovers around 10 per cent and WPI stands at – 1.14 per cent.
• In the current fiscal year, the RBI has mandated 5 per cent provisioning for all banks on their restructured loans with an outstanding due of Rs 1 crore or less. Since most of the loans are below Rs 1 crore, this provisioning is a burden for banks and will impact their profitability.
• Various stimulus packages, additional expenditures and reform programmes such as NREGA, etc., have made the government borrow Rs 3.6 lakh crore, widening fiscal deficit to a dangerous level of 6-7 per cent of the total GDP. This increased borrowing has resulted in a rise in bond yields, an indicator of interest rate movements. The benchmark 10-year G-Sec 6.05 % 2019 shot to 7 per cent on account of large government borrowings.

Conclusion:
In their successive monetary policy reviews, the RBI gave enough indications to banks about pruning their lending rates. In response, banks cut their prime lending rates (PLRs) and provided credit at much lower interest rates but the need to revive the beleaguered economy calls for further reduction in lending rates, compared to the ones seen in 2003. The interest rates on new loan accounts have already plummeted to a significant level. Since there is abundant liquidity and business/consumer sentiments are positive, a drastic cut in policy rates seems unlikely. So, we can assume that the lending rate would be stable in the near future with an affront negative view. The picture would be cleared only after Shri Pranab Mukherjee's budget pitara opens on July 06, 2009 and the RBI's monetary policy in mid-July, its first quarterly review after a stable government in New Delhi.