Rally in rate sensitive real estate segment likely to stagnate

Inflation control at the cost of growth seems to be the message sent by RBI in the Monetary policy first quarter review. RBI has hiked key rates in order to curb credit growth and has simultaneously lowered its expectation of GDP growth rate to 8%. RBI hiked repo rate by 50 bps 8.5 % to 9.00% and CRR by 25 bps to 9.0 per cent with effect from the fortnight beginning August 30, 2008. Both the repo rate and CRR is now at a level of 9 per cent, last seen 8-9 years back.

RBI has given strict instructions to provide only high quality credit and hence real estate developers are going to find it more difficult than before to get credit in this liquidity crunched scenario. Moreover, there is increasing pressure on banks to increase interest rates with the hike in CRR and repo rates. There will be resetting of EMIs on home loans further putting pressure on the demand for real estate .

A large part of private equity funds have been going into the real estate space. The new monetary policy tightening would mean fund managers will have to go back to their drawing boards to reassess the risks and calculate the expected rate of return. Whether it translates into further drop in PE deals this year is to be seen, but the monetary tightening would surely mean that fund managers would have to be more cautious in pouring money into real estate.

The real estate sector which had been one of the prime targets of PE firms with large transactions through a SPV route of investment has already seen a moderation. While big budget deals have dried up even smaller deals are taking more time to take place. Valuations in the public marlet has shrunk significantly which has affected the project valuations and hence the deal sizes.

Inflation figures are looking higher than ever and the central bank announced an extremely hawkish policy to control the spiraling prices, and ready to forsake growth in the process. RBI has given clear indications that inflation is not going to come down anytime soon. It has projected a “realistic” inflation rate of 7 per cent by March 2009. However, the GDP growth rate has been revised downwards as well. The expectation now stands at 8 per cent for FY09 as against 8-8.5 per cent as announced in the Annual Policy in April, earlier this year.

After the policy was announced, BSE Realty Index tanked by 5.4%, the highest after the BSE Bankex which fell over 8.4 % while Nifty and Nifty Junior dropped by 5.33 per cent and 3.28 per cent respectively after the rate hike.