RBI warns against realty asset bubble

Buoyant property prices pose risk to banking: Rakesh Mohan.

The strong demand for homes and home finance is expected to keep property prices firm, posing a risk to the banking system, given the absence of transparency in the real estate sector.

The elevated realty prices along with non-transparency in the real estate sector may lead to an "asset bubble" and pose risks to the banking system, according to Reserve Bank of India (RBI) Deupty Governor Rakesh Mohan.

In addition to the substantial backlog in housing, further growth in income and pick-up in the pace of urbanisation are expected to maintain demand for housing and housing finance high over the next few years, Mohan said in his address at the Yale University in the US on India's financial sector reforms.

Mohan pointed out: "In view of the expected high demand, pressure on real estate prices may continue. Moreover, real estate markets are characterised by opacity and other imperfections in developing countries.

Such developments can easily generate bubbles in the real estate market because of problems in the elasticity of supply and information asymmetries."

The acceleration in growth over the past few years has brightened medium-term prospects for growth of the Indian economy. The domestic savings are expected to finance the bulk of the investment requirements. In this context, the banking system will continue to be an important source of financing and there could be strong demand for bank credit, he said.

Turning to policy on tackling inflation, he said, "In India, we have not favoured the adoption of inflation targeting, while keeping the attainment of low inflation as a central objective of monetary policy."

Apart from the legitimate concern regarding growth as a key objective, many other factors suggest that inflation targeting is not appropriate for India. First, unlike many developing countries India has a record of moderate inflation.

Second, inflation targeting needs an efficient monetary transmission mechanism through the operation of efficient financial markets and absence of interest rate distortions. Indian financial system is yet to show these features in a substantial measure.

Third, inflationary pressures still often emanate from significant supply shocks related to the effect of the monsoon on agriculture, where monetary policy action may have little role.

Finally, it is difficult to have universally acceptable measure of inflation in large economy like India due to various regional differences and continuaton of market imperfections, he added.