Bringing the house down

After more than five years during which interest rates on housing loans moved only downwards, the first signs of reversal have emerged, with HDFC announcing a 25 basis point increase in its benchmark fixed rate. Other lenders are sure to follow and this means that people who already have loans outstanding as well as people looking to borrow in the near future will end up paying a little more each month to their housing finance provider.

Concerns have been voiced about the impact this will have on both the overall demand for housing, which has been a key driver of the recent industrial recovery, and the ability of households to continue to service their debts as monthly instalments increase.

On both counts, there will undoubtedly be some impact. However, their magnitude is unlikely to be such as to pose a systemic risk, either to the economy as a whole or to the housing finance sector. From a macroeconomic perspective, the demand boost that housing construction provided over the last two or three years would, in any event, have had to be substituted by a new driver.

The interest rates that have been seen in the last several months were the outcome of a combination of three factors"" financial deregulation, sluggish demand for credit by industry, and low inflation. While the first has had a permanent impact on the average rate of interest over a business cycle, the other two are bound to vary over the cycle and some tightening of rates was inevitable as the industrial recovery continued and the rate of inflation moved up.

In short, to expect the macroeconomic boost from falling interest rates to continue forever, is unrealistic. Something has to take its place; most people expect that this will be an upturn in investment in new capacity across a range of industries. There are early signs of this happening. If the trend consolidates, the economy will not see a decline in its growth momentum.

What about the probability of default? Here, the intense competition in this sector is likely to work in the borrowers' favour by keeping rate increases to a minimum. Considering that rates have come down from levels of 16 per cent just six or seven years ago to around 8 per cent now, 25 basis points is a very small increase.

Even if the upward pressure persists for a while, there is no expectation of a return to the days of double-digit interest rates. There is another reason to believe that large-scale default is simply not possible.

Most borrowers have substantial amounts of personal equity in their houses""their leverage as a result of borrowing is typically quite low. Nobody in his right mind would surrender an asset whose value is substantially higher than the loan taken against it. Marginal increases in monthly commitments will simply be taken in stride.