The subprime crises triggered by a dramatic rise in mortgage delinquencies and

foreclosures in the United States ,lead to major adverse consequences for banks and
financial markets around the globe. Administered interest rates are one of the major
measures for controlling the money supply in an economy. Bank rate, repo rate and
reverse repo rate are administered by The Reserve Bank of India. The records show
high fluctuation in the interest rates in the past in India. The Reserve Bank of India
(RBI) made drastic cuts in interest rates during the recession period to make sure
that the banks and individuals get the benefit of higher credit availability. The
Government of India had the stimulus package for the India Inc., where as the
Banking sector has been successfully managed by RBI measures.

• Meaning of Interest Rates/Policy rates: Interest rates can be defined

from different perspectives, for an Individual an interest rate is the price a
borrower pays for the use of money, they do not own. For an Organization,
Interest is a fee paid on borrowed funds/assets. It is the price paid for the use
of borrowed money or, money earned by deposited funds. For General
Banking, An interest rate is the amount received in relation to an amount
loaned. An interest rate is the amount received in relation to an amount
loaned, generally expressed as a ratio of rupees received per hundred rupees
lent. Interest rates can be classified as specific interest rates and interest
rates in general. Specific interest rates area interest rates on a particular
financial instrument market, these rates are driven by market forces (i.e.
 Demand and supply). General interest rates, such as bank rate are
administered interest rates i.e. re set by some established group ( bank rate
is administered by central bank of a country, RBI in India ).
• Bank Rate,Repo and Reverse Repo Rate: Every central bank functions as
a controller of credit in an economy. One of the measures to control credit is
by the way of monitoring the bank rate, repo rate and reverse repo rate.
Bank rate is the rate at which the central bank (R in INDIA) lends to
commercial banks and acts an important benchmark in determination of
interest rates charged by banks from the ultimate borrowers. In brief, raising
bank rates by raising bank rate, central bank raises the cost of borrowing.
This forces the commercial banks to raise in turn the rate of interest from the
public and vice versa. Changes in bank rate are generally referred in terms of
basis points. A basis point (often denoted as bp) is a unit relating to interest
rates that is equal to 1/100th of a percentage point per annum. It is
frequently but not exclusively used to express differences in interest rates of
less than 1% pa. It avoids the ambiguity between relative and absolute
discussions about rates. For example, a “1% increase” from a 10% interest
rate could refer to an increase either from 10% to 10.1% (relative), or from
10% to 11%. Similar, are the repo and reverse repo rates. Whenever the
banks have any shortage of funds they can borrow it either from Reserve
Bank of India (RBI) or from other banks. The repo rate is the rate at which
the banks borrow these excess funds. The borrowing bank mortgages its
government securities to carry out this loan transaction. A reduction in the
repo rate will help banks to get money at a cheaper rate. When the repo rate
increases borrowing from RBI becomes more expensive. Reverse Repo rate is
the rate at which Reserve Bank of India (RBI) borrows money from the
various commercial banks. An increase in Reverse repo rate can cause the
banks to transfer more funds to RBI due to attractive interest rates. It can
cause the money to be drawn out of the banking system.

RBI Actions During Global Recession/Subprime Crisis

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 beginning 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.

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 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.

YEAR BANK RATE

2006 5.25 5.50 5.50 5.50 5.50 5.50 5.75 6.00 6.00 6.00 6.00 6.00
2007 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00
2008 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 5.00
2009 4.00 4.00 3.50 3.25 3.25 3.25 3.25 3.25 3.25

Date Repo Reverse repo

26-oct-05 5.25 6.25
24-jan-06 5.50 6.50
9-jun-06 5.75 6.75
25-jul-06 6.00 7.00
31-oct-06 6 7.25
23-dec-06 6 7.25
6-jan-07 6 7.25
31-jan-07 6 7.50
17-feb-07 6 7.5
3-mar-07 6 7.5
30-mar-07 6 7.75
14-apr-07 6 7.75
28-apr-07 6 7.75
4-aug-07 6 7.75
10-nov-07 6 7.75
26-apr-08 6 7.75
10-may-08 6 7.75
24-may-08 6 7.75
11-jun-08 6 8.00
25-jun-08 6 8.50
5-jul-08 6 8.5
19-jul-08 6 8.5
30-jul-08 6 9.00
30-aug-08 6 9
11-oct-08 6 9
20-oct-08 6 8.00
25-oct-08 6 8
3-nov-08 6 7.50
8-nov-08 6 7.5
8-dec-08 5.00 6.50
January 05,2009 4.00 5.50
January 17,2009 4 5.5
March 05,2009 3.50 5.00
April 21,2009 3.25 4.75
Impact of RBI’s Actions

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.

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 sufficient liquidity in
the banking system and as the lending rate reduces, the cost of funds for the
developers would decrease leading to improved cash 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 Stabilization 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 cannot 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.