Govindraj Ethiraj: Don't Cut Interest Rates

DOUBLE EDGE

For many, it's the brilliant lights, billboards and energy of Times Square that brings them there. On this moderately chill New York afternoon, I am focused on the big news tickers flashing past. As I watch, in an hour, the fate of Bear Sterns, another Wall Street giant, is sealed. Or protected, depending on how you look at it.

Just when you thought the mortgage crisis had seen the worst, there's more. As I watch the milling tourists and the dazzling Nasdaq screen, which am sure is not such a big attraction now, I also think back of India's own property crisis. And how the only distinction being no one seems to realise or acknowledge it.

This is not a crisis of loans going sour as you might imagine, at least not yet, but property rates rising to stratospheric levels and staying there. And of course the prospect of what might happen if they reversed direction somewhat suddenly.

In late 2005, I attended a colleague's wedding reception in Mumbai. Once the formalities were dispensed with, the talk turned to the booming property and stockmarkets.

Everyone I encountered was doing some amazingly simple math. Can I find Rs 10 lakh and put it as down payment. Because if I do, I can buy a Rs 40 lakh or maybe even Rs 50 lakh house and pay less than Rs 40,000 as equated monthly instalments (EMI) for the loan.

Meanwhile, I put the house on rent. For that price in most cities in India, particularly Mumbai, I could get a rent of at least Rs 20,000 to Rs 25,000 and I am pretty much home. "Did you hear, Alok is thinking of buying a house in Kochi?" a colleague asked. Why would a Delhi boy buy a house in Kochi, I asked. "Because it's cheap."

The colleague herself had one house on rent, lived in another and was planning a third buy then. I am pretty sure, with the stock option windfall that would have followed, she would have either rustled up 10-20% down payment or maybe even bought it outright. The stock markets were keeping step with the property market boom.

Till the inflation-weary Reserve Bank of India (RBI) had the presence of mind to start raising interest rates, almost nine times since 2004. So from a bottom of 7%, where every senior manager in a knowledge company (mostly) had become a mini real estate mogul, rates now hover in the region of 11%, where there is some sanity. Of course "industry" is complaining that growth is suffering, but let's stay with property.

I am not sure what has changed so fundamentally in the quality of our lives that a house I would pay Rs 50 lakh for in 2005 is worth Rs 1.5 crore now in 2008. And what perplexes me even more, as it has in the last few years, is why nobody cares.

Actually, we must be one of the few countries that stand unruffled in the face of an asset price bubble like this. Mostly, we feel proud that, along with our billionaires, our property prices rule on top of the world, despite having some of the worst housing and housing infrastructure. I don't mean inside the apartments of course.

Surely there are supply-focused solutions to look at. Surely, a committee, even if it's just another one, could look into short- and long-term solutions to making housing affordable.

That's another story. I am convinced that nobody does care, except maybe the RBI, the only institution to my recollection that has expressed some concern over low interest rate fuelled asset bubbles.

And the only way the RBI can act in such circumstances is to tighten interest rates and hold on to them, the rest of the world (Federal Reserve) be damned.

The RBI is of course fighting tooth and nail to hold interest rates while every constituency, political, business and economic is baying for lowering them. So far, the RBI has held on admirably. Whether it will manage to hold on is a question mark. I strongly feel it should, because high interest rates are the last reason growth will be affected.

The good news is that an economic slowdown may exert pressure on asset prices, both in the commercial and non-commercial space. For both it's good news. Land costs are making it difficult for existing industries to expand and new ones to come up such as in retail. For the common man, it's about affordable housing, which is obviously a non-issue in India.

The RBI must hold interest rates, till asset prices and maybe inflation drift firmly lower. Dropping interest rates could unleash precisely the kind of financial frenzy we want to avoid, though from a cause and effect point of view, it's too late either way. The Bear Sterns and all the mortgage-backed blowout stories surely teach us the folly of excess and low interest rates.