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Rate hike may be counterproductive: RBI

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Press Trust Of India

Last Updated: October 25, 2006, 18:48 IST

Rate hike may be counterproductive: RBI

Raising interest rates excessively to prick housing bubble may prove to be counterproductive, says RBI.

Mumbai: Ahead of its quarterly policy review, Reserve Bank has expressed doubts on the efficacy of "pre-emptive" raising of interest rates to prick a housing bubble.

"There is a need to carefully evaluate consequences of monetary policy actions, specially when the housing market is seized by price bubbles. Raising interest rates more than what is required for overall price stability purposes may prove to be counterproductive," the RBI said in "Occasional Papers."

Such a policy could also be potentially damaging for other sectors in the economy, the central bank said in a chapter on "Identifying Asset Price Bubbles in the Housing Market in India-Preliminary Evidence."

The papers have been issued at a time when several commercial banks have expressed the view that there should not be any further hike in short term rates to contain inflation, which has crossed five per cent mark.

The bankers argue that with oil prices falling and seasonal factors tapering off, the Reserve Bank should not hike rates as it may impede high growth momentum.

The RBI study said, direct measures taken for demand compression may be less worthwhile than sectoral measures such as withdrawing or reducing regulatory accommodation.

As a preemptive measure, the RBI in its annual policy statement for the current fiscal had increased general provisioning for residential housing beyond Rs 20 lakh and commercial real estate from 0.40 per cent to one per cent.

The banks will now have to set aside Re one for every Rs 100 loan given for the housing sector beyond Rs 20 lakh against the earlier requirement of 40 paise.

The risk weight on bank exposure to commercial real estate had also been increased from 125 per cent to 150 per cent.

The study sounded a word of caution on the dangers of building up of systemic credit risk and the instability of the financial system as a whole from the rising level of loans taken by families in India for housing and other retail finances.

The study said concerns regarding the sustainability of increasing growth in housing and other retail financing by financial institutions now appear to be arising given the increasing load of household debt.

Though India has not so far experienced the pangs caused by bursting of bubbles in the housing sector, the need to take pre-emptive policy actions can hardly be overemphasised in the light of the experience in other countries, the RBI said.

"As part of calibrated policy response, the Reserve Bank has been gradually nudging financial institutions to exercise due diligence in the assessment of credit risks for exposures in the housing sector, while increasing the regulatory risk weights/provisioning for housing and real estate loans," the study said.

The papers said the extent of speculation in the housing market is subdued and is primarily supported by lower interest rates and easy availability of credit.

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    On international scenario, the central bank said the strong upsurge in the housing market in the US is a source of concern, especially for the global financial market.

    first published:October 25, 2006, 18:48 IST
    last updated:October 25, 2006, 18:48 IST