Realty: RBI, FM reading the same but from different pages

Looks like the Reserve Bank of India and the finance ministry are again at loggerheads. However, this time it is not over interest rates, but over taming soaring realty prices.

While Finance Minister P Chidambaram has in the recent months asked banks to relax lending norms to help builders complete their incomplete residential projects, the RBI wants banks to go after the builders to recover their loans, rather than restructuring them.

Strategically, both will have the same end- decline in prices due to increased supply in the residential market. Chidambaram’s contention is that if banks increase funding builders will be able to complete projects faster. If, as per the RBI’s directive, banks insist on recovery, builders will be forced to sell properties, in effect increasing supplies in the market.

However, the RBI’s rejection of banks’ plea is also a stern warning over the misuse of restructuring of loans.

When property prices crashed four years ago, instead of forcing builders to sell property at prevailing market rates and repaying the bank loans, banksallowed them to roll it over. Builders paid high interest but not the principal amount.

But by relaxing lending norms further, the finance ministry is only exposing banks to more risks. If too much money is made available to builders, developers will continue to hoard projects and a price correction will be delayed.

Had banks not restructured loans to the sector, the real estate industry would have been healthy. Keeping this in mind, the RBI has finally begun cracking its whip on exposure to the realty sector.

“The central bank believes that if banks are permitted to restructure the loans without providing for losses, they will lose the urge to insist on prompt payments from builders, who in turn would continue to hold onto prices even if sales are slack,” the Economic Times reported today , quoted two bank officials.

The move by the Reserve Bank of India could definitely help soften property rates as builders will be forced to fast-track their sales and unlock value from several vacant flats that are lying unsold through the country in order to repay the bank loans.

Secondly, it should also improve the cash flows and transparency in the system. The biggest grievance of financial institutions has been new launches. Most often, bank loans meant for one project are used to kick-start another or are diverted to buy more land.

This, in effect, results in an inflated cost of an apartment or land space as the builder gets to hold the property and demand a premium for it.

If builders are forced to repay their debt (since the central bank will prevent the loan from being a sub-standard) then they will not be able to hold onto prices, which in the long term can help rein in the artificially high property prices and in effect take care of this key contributor to high inflation.

Clearly, the RBI has done its bit by asking banks to take a hit on loan recast. The bigger question is can Finance Minister P Chidambram can do his bit by breaking this builder-investor-politician cartel to clean up the real estate market and ensure affordable housing in India?

For, the current pricing policy is the result of the unwholesome business model adopted by builders. They pass on the risks of unviable projects to financiers, banks, buyers and even investors to ensure their own safety and profitability by deliberately fuelling inflation.

The only way out is to break this cartel. Chidambaram is known to be a task master. But will he crack the whip on realty too?