Real estate tightrope

Most, if not all, observers of the real estate sector would be inclined to agree that recent price increases have shown signs of being a bit of a bubble. The upward pressure on prices has been caused in part by large inflows from abroad, both directly in the form of external commercial borrowings (ECBs) and indirectly by way of equity investments in real estate companies. Given that a significant chunk of real estate transactions are funded by borrowing, a collapse in prices does have implications for the health of the financial sector. The magnitude of foreign inflows also gives the situation a balance of payments dimension, which links it to the fundamental macro-economic problem of the day: how to accommodate the huge inflow of foreign exchange while keeping a lid on both domestic inflation and rupee appreciation.

While it is usually futile to try and solve macro-economic problems with solutions geared to individual sectors, in the current scenario the thinking clearly is that every little bit helps. The government recently imposed curbs on external borrowing to fund real estate development, which, on the face of it, simultaneously addresses the sectoral problem of a price bubble and the macro-economic problem of excessive inflows. Now, it has been reported that the second channel of external funding, i.e. equity, will also face restrictions, with a view to further squeezing the flow of resources to this sector.

While there is visible logic in the government's pursuit of these dual objectives and the instruments being used, it must be emphasised that the long-term consequences of these measures may well be adverse and the realisation of benefits from them will largely depend on the perception that they are strictly temporary. Who can argue that significant investments in real estate are not critically needed, whether in housing or in commercial properties? The recent sealing drive in Delhi has highlighted just how short the city is when it comes to commercial space. As tighter enforcement of zoning regulations spreads across the country, other cities will begin to experience similar pressures. Nor is the state able to do very much about this; it is barely able to keep pace with the surging demand for basic infrastructure services, let alone build and maintain real estate. There is really no alternative to the private sector; given this, one also has to accept that developers will seek the lowest-cost sources of funds, whether both domestically and abroad. A squeeze on funds goes against this imperative and in fact could make the pricking of the real estate bubble a self-fulfilling prophecy.

A second issue relates to the appropriateness of alternative ways in which to deal with a bubble. Although there is no firm consensus on the subject, a practical view is that it is better to impose higher provisioning requirements on institutions that are exposed to the underlying assets than to precipitate a price crash with the use of blunt instruments like a funds squeeze. The Reserve Bank of India has certainly been following this approach with respect to real estate exposures, but the view now appears to be that this is not adequate. However, there is only a thin line between managing asset price inflation and precipitating a crash. In increasing the dependence on blunt instruments, the risks of falling off the tightrope increase.