Every action has an equal and opposite reaction. After the Reserve Bank of India (RBI) increased the repo and reverse repo rate to 7.25% and 6.25% respectively, the banks and financial institutions have also decided to follow by increasing their lending rates.
In layman’s term, repo rate is the rate at which RBI lends short term funds to banks and RBI accepts reverse repo rate is the rate at which RBI accepts short term deposits from banks.
The RBI projection of moderated economic growth to around 8% for 2011-12 from 8.6% in 2010-11 will surely affect the general mood of investors as a result it will bring down the return on investment in the economy.
The combination of rising interest rates and slowdown in the economy has a great impact on the activities of real estate sector as well. The major reason for the lowering of the economic growth is because of the effort taken by the central bank to contain inflation which is presently hanging around 9%. It is a known fact that whenever financial institutions raise their lending rates it indirectly affects the cost-sensitive Indian real estate market.
The common impact is the rise in the cost of construction for developers and this increase in repo rates by RBI certainly is not the best time for real estate market. As a precaution measure the banks have already taken a cautious approach to real estate lending and reduced their exposure to the sector. And as a consequence of that most developers are now raising a larger component of their construction costs from the private sector. The simple idea that the funds come at a higher cost of borrowing has already increased their construction costs. In this scenario, it is obvious that the developers will pass on the incremental burden to the buyers to maintain their profit margins.
The market for residential real estate market is far from vibrant at the moment. In a case where staying competitive and selling stock is of the utmost essence, developers are unlikely to increase the cost of their units and thereby risk losing more customers. The overall impact of this increase will surely slow down the activities in the real estate sector.