BUSIN E S S

BRIEF ING
Impact of Monetary Policy
2009

AP RIL 2009 | A CUSHMAN & WAKEFIELD RESEARCH PUBLICATION

CO N T E N T S I N D IA : A N N UAL MON E TA RY POL ICY

1 India: Annual Monetary Policy The Annual Monetary policy is a strategy outlined by the Reserve
Bank of India to control costs, supply and availability of money within
2 Previous Expansionary Policy
the system in order to balance growth and inflationary pressures
Actions
faced by the economy. The previous RBI governor, Dr.Y.V. Reddy had
3 RBI Actions introduced contractionary policies where the cost of funds (money)
4 Impact was increased in order to curtail growth and reduce inflationary
pressures. Contractionary policies which mopped up liquidity from
the economy, coupled with the global turmoil resulted in growth
moderation and had ripple effects across all industries including real
estate. Mr. Subbarao, reacting to the extreme conditions posed by the
global economic recession and its apparent effect on India’s economy,
For more information please contact: has adopted a more expansionary policy. Internationally, after having
failed to restore order via more conventional methods, central banks
Anurag Mathur have resorted to unconventional measures such as quantitative and
Cushman & Wakefield
4th Floor, Pine Valley credit easing. The RBI on the other hand has been ahead of the
Embassy Golf Links Business Park economic curve by taking corrective measures to prevent a degrowth
Intermediate Ring Road and has enough “dry powder”1 to use without resorting to the
Bangalore, India
unconventional methods where the impact of reviving credit flow and
Tel: +91 80 4046 5555
Anurag.Mathur@ap.cushwake.com spurring aggregate demand is not measured historically.

REAL GDP GROWTH (%)

1Q (April – Jun) 2Q ( Jul – Sep) 3Q (Oct – Dec) April - Dec

2007-08 2008-09 2007-08 2008-09 2007-08 2008-09 2007-08 2008-09
Agriculture 4.4 3 4.4 2.7 6.9 -2.2 5.5 0.6
Industry 8.5 5.2 7.5 4.7 7.6 0.8 7.9 3.5
Services 10.7 10.2 10.7 9.6 10.1 9.5 10.5 9.7
Overall 9.1 7.9 9.1 7.6 8.9 5.3 9 6.9
Source:Central Statistical Organisation (CSO)

Unlike believed initially, the Indian economy has not decoupled although it is less reliant on the
global economy as compared to other emerging nations mainly due to the low exposure towards
high risk assets in foreign countries and exports being less than 15% of GDP, as per the RBI, thus
the demand being more domestic than global. This, however has not spared India from growth
1: Dry powder - term used to imply possibility of further action.

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moderation or a cyclical downturn as it is still connected to the world economies and the RBI has
taken this into account. After the stellar performance of 8.9% annual average for the 2003-2008 (5
year) period, the growth declined considerably in 3Q 2008-09. The RBI has forecasted the GDP
growth for 2008-09 in the range of 6.5- 6.7%. It has adopted a bearish stance on the growth of the
economy for the current fiscal year and has set the growth target at 6%. The fiscal and monetary
measures taken during the fiscal year 2008-09, which were geared to arrest the falling rate of
growth, are expected to show positive effects in the economy over the next few quarters. While
it is acknowledged by the RBI that private investment is likely to remain subdued it is imperative
that private investment remains strong for the economy to enter a high growth trajectory that was
previously being followed.

Inflation rates
(in percentage terms)
INFLATION RATES

Wholesale Price Index Consumer Price Index

Source: IMA

The RBI is now encouraging growth and propagating an expansionary policy in order to stimulate
demand and is more comfortable to follow this path due to the ebbing inflationary concerns
witnessed in the economy. The Wholesale Price Index (WPI) inflation which reached its peak at
around 12.91% in August 2008, witnessed a sharp y-o-y decline reaching 0.26% in March 2009 as
against 7.75% same time last year. The WPI inflation further declined in April 2009 to reach 0.18%
and is expected to become negative in short term (early 2009-10) as per the RBI. Although the
Consumer Price Index (CPI) inflation is still close to double digit figures, it is forecasted to moderate
to comfortable levels as per the RBI in the short to mid term. The WPI inflation is projected to be
around 4% by end of March 2010 which relieves India from worrying about deflation that developed
economies are trying to prevent. The ample liquidity in the banking system is noted by the RBI and
the fall in credit growth has also been taken into account and prompted their decision in pursuing a
more expansionary policy.

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PREVIOUS EXPANSIONARY POLICY ACTIONS

Since September 2008, RBI has taken multiple actions in order to ensure that the economy does
not suffer a massive downturn. The RBI has cut the repo rate by 400 basis points from 9% to 5%,
reverse repo rate by 250 basis points from 6% to 3.5% and the CRR by 400 basis points from a high
of 9% to the current 5%. Where as the Statutory Liquidity Ratio (SLR) was reduced from 25% to
24%. The RBI has also reprimanded the Banks which have been slow in passing on the benefits
of the lower interest rate onto the borrower. It clearly pointed out that the interest rate cuts by the
public sector banks have been in the range of 1.25%-2.25%, 1%-1.25% for private banks and 1% for
foreign banks. The slackness in passing on benefits to the consumers can be seen in a comparison
between reactions of banks to RBI policies in 2004 and 2008. Towards the begining of 2004 the
RBI key policy rates were at approximately similar levels although private banks were charging about
7.5-8% during that time and are currently charging approximately 10-11% for home loans.

Comparison of Policy Rates

Q4 FY 2003 - 04 Q1FY 2009 - 10

Cash Reserve Ratio 4.5% 5%
Reverse Repo Rate 4.5% 3.25%
Repo Rate 6% 4.75%
Statuary liquidity ratio 25% 24%

Source: Reserve Bank of India

Historical Policy
Values in percentage
terms

Source: Reserve Bank of India & C&W Research

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Lower inflation has resulted in higher real interest rates which is essentially compounding the costs
for the borrower as inflation is at close to negligible levels while borrowing costs are still at double
digit. This means that the real cost of borrowing is considerably high. For example, one borrows
INR 100 at 10% per annum thus at the end of the year he would have to pay back INR 110 but if
inflation was at 10% then he essentially borrowed at no cost as inflation was equal to the borrowing
cost (interest paid). However, if he borrowed at 10% and inflation was at 1% and he paid back
INR 110 while the value of his money would be equivalent to INR 101 thus the differential paid is
INR 9 which is essentially a higher cost of borrowing. In such a situation it is best for a person to
foreclose all loans and not borrow more, resulting in poorer demand and lower credit growth. The
RBI recognized this in their policy and expressed that even with the long term inflation target of 4%
real interest rates continues to remain at a very high level and to counter this phenomenon has used
moral suasion in order to get banks to bring down lending rates.

The RBI noted that the policy changes undertaken by them have not been followed through
completely or as fast as desired by the banks in lowering their lending rates. While the RBI reduced
its lending rates (repo rate) by 4%, the banks brought down their interest rates only by approximately
0.5-1.5%. The banks in their defense have sighted reasons like high cost of funds due to large
amounts of deposits made previous year at 9 - 11% and as these cost of funds come down, which is
likely to take place during the next 3 quarters, the lending costs would also start to decline.

RBI ACTIONS

The RBI has adopted a comparatively more conservative target of 6%, as compared to the
Government’s 7% GDP growth target for the current fiscal, in light of the global downturn resulting
in moderation of growth and muted inflationary pressures that are being experienced currently by
the Indian economy. The policy announced a cut in repo and reverse repo by 25 bps in order to
encourage lowering of lending rates, increased lending and stimulate aggregate demand within the
economy in order to mitigate downside risks. After the additional 25 bps cut, currently the repo
rate has lowered down to 4.75% and reverse repo rate to 3.25%. There is also a clear indication that

Monetary Policy 2009-2010

As per the RBI the monetary policy stance for 2009-10 will broadly be as follows:

• Ensure a policy regime that will enable credit expansion at viable rates while preserving
credit quality so as to support the return of the economy to a high growth path.

• Continuously monitor the global and domestic conditions and respond swiftly and
effectively through policy adjustments as warranted so as to minimise the impact of adverse
developments and reinforce the impact of positive developments.

• Maintain a monetary and interest rate regime supportive of price stability and financial
stability taking into account the emerging lessons of the global financial crisis.

Source: Reserve Bank of India

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the central bank will continue to monitor the economic performance as downside risks continue to
persist in the economy and necessary action will be undertaken as deemed favorable which translates
to possibly more rate cuts in the short term.

IMPACT

Lowering of the interest rates would first impact the deposit rates offered by banks as they bring
down their cost of funds and then pass on the benefits to the borrowers by lowering lending rates.
The impact of lower deposit rates will make fixed income instruments less attractive in the short
to medium term. The sharp recent correction in real estate prices that has led to rationalization in
property prices has now made real estate a relatively more attractive option. As the fixed deposit rates
continue to fall real estate as an asset class will start attracting more investments and become a more
preferred investment vehicle.
Comparison of Real Estate & Fixed Income options

Investment Options Fixed Deposits 1-3 Commercial Real Residential Real Retail Real Estate
year Estate Estate
Yield/Returns 8-9% 8-11% 3-6% 9-12%

Tax Impact Interest taxable Relatively more Relatively more Relatively more
Tax efficient as Tax efficient as Tax efficient as can
can write off can write off write off expenses
expenses etc. expenses etc. etc.
Capital Gains Capital gains only if Potential capital Potential capital Potential capital
interest is reinvested gains gains gains
Source: C&W Research

The cut in both reverse repo and repo is expected to induce banks to reduce their lending rates
as seen with the immediate cut in lending rates by certain private banks of 50 bps. This reduction
in turn will add more spending power of the borrowers as existing loans get cheaper resulting in
increased discretionary income which will start to draw the consumer to spend again and help in
boosting demand. The new loans generation will also be done at a lower rate which will in turn
increase the borrowers’ affordability. As developers procure additional loans at a lower rate they
would be able to pass this benefit on to the end user with lower capital values. The lower lending
rates will also result in lower EMI payment resulting in higher affordability, as the interest rates
continue to soften in the short to medium term. As per the policy the credit to housing by banks
has reduced from 12% on Feb. 15, 2008 to 7.5% on Feb. 27, 2009 from the previous year. Showing
the abating demand which has impacted real estate prices resulting in a correction of 20-30% across
India from the peak levels established in 2008.

On the commercial real estate front, developers who were facing a liquidity crunch, will be able to
abate the stringent cash flows as there is already sufficent liquidity in the banking system and as the
lending rate reduces, the cost of funds for the developers would decrease leading to improved cash

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flows. This in turn would help many in completing their unfinished projects and meet their expected
deadlines. Although fears in the system remain that adequate lending might not occur to the real
estate sector due to risk aversion that has developed by banks to control rising NPAs.

The only dampener to the lower interest rates would be the government borrowings which the
RBI has assured will be carried out smoothly with sufficient liquidity in the system being provided.
During the first half of the current fiscal year, planned open market operations (OMO) purchases
and Market Stabilisation Scheme (MSS) are expected to add further liquidity of approximately INR
1,20,000 crore in the financial sector during in the short term. This expected liquidity along with the
rate cuts lead to the long term yields falling after the policy announcement and analysts are expecting
the long term yield to drop below 6% in the short term. The dropping of long term yields and
increasing liquidity is expected to keep the cost of funds relatively low for the banks amounting to
lower lending rates in the short to medium term. A regime of similar components namely low lending
rates, ample liquidity was found during the year 2003-04 which led to the start of the real estate bull
run. Thus we find that the seeds for the next growth cycle being sowed in the current downturn.

As experienced in 2002-03 the real estate market remained subdued due to lower economic growth,
India is again expected to witness moderate growth during the current financial year which will
translate to suppressed real estate prices. International agencies such as the IMF and World Bank etc
are pegging revival of the economy in the first half of 2010 and momentum is likely to be gained
only in the second half of calendar year 2010. Due to the economic uncertainty with forecast ranging
from 5%-7% one can not presently foresee the start of the next real estate bull run, however, the
market is likely to bottom out during the first half of the next financial year, making it apt for the
investor to invest in properties at a discounted prices during the year with a long term investment
horizon.

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