Indian demand responding to rate hikes?

FT reports that large increase in morgage cost and other consumer finance is having an impact. This is not surprising - the question is whether rising incomes will dampen any slowdown or whether there is a personal credit bubble waiting to be burst. I continue to have confidence in the long term prospects of India but also remain wary of the short term. With valuations rich and rates rising, the risk/reward of Indian stocks seems very unfavorable to me. However my institution continues to allocate to private equity funds given their long term focus.

India’s mortgage holders feel pain of rate rises

By Joe Leahy in Mumbai

Published: April 25 2007 01:18 | Last updated: April 25 2007 01:18

When Sanjay Kapadia, a Mumbai consultant, took out a mortgage on a flat in August, he opted for a variable rate to avoid the high charges attached to fixed-rate loans. It proved to be an unlucky choice.

Starting in December, the central bank began tightening interest rates. The average mortgage, already inflated by big rises in property prices, became 250 basis points more expensive, an increase of more than 20 per cent in the space of five months. “I pretty much got hit with a double whammy. I paid 50 per cent more than an apartment would have cost previously and I got hit with higher rates. Now even a 25 basis point jump hurts,” he said.

Mr Kapadia’s hardships are typical of the strains on Indian homebuyers following what has become a war by the Reserve Bank of India on inflation, which is running above 6 per cent.

While it is too early to see the impact on credit quality, some bankers are already warning that the RBI’s campaign could have consequences for their loan portfolios.

“We have to keep an eye on the credit risk building up in the system,” said Sanjay Nayar, chief executive of Citigroup in India. “It’s going to become more and more important to keep that at the front of our minds rather than at the back of our minds.”

Chetan Ahya, of Morgan Stanley, said mortgage rates had risen from a low of 7.5 per cent in September 2004 to 12 per cent. More than half the rise had occurred in the past five months.

On Tuesday the RBI held its key lending rate at 7.75 per cent but the effect on consumer demand of its rate increases and other measures to tighten credit supply has been dramatic.

Car sales rose only 2.9 per cent in March from a year earlier, the slowest gain in 13 months. Output of consumer durables rose 1.6 per cent year on year in February, against 5.3 per cent in January.

The housing market has been more stubborn. Karthik Srinivasan, analyst at Icra, the ratings agency, said the largest mortgage lenders were reporting 25-30 per cent loan growth, down from previous levels in excess of 30 per cent but above the government’s target of 20 per cent.

Some bankers said that, while demand for mortgages and consumer loan growth were expected to slow, they saw no marked deterioration in credit quality.

Nick Winsor, head of personal financial services at HSBC India, pointed to the equity many Indian borrowers had in their homes, estimated by some at up to 30 per cent. The macroeconomic environment remains benign: the rate increases are designed to take only some of the froth out of the economy. Wages are rising and job creation is proceeding.

“Clearly the rising interest rates will mean it’s more expensive for people to borrow but generally all of the data we have suggest that rising incomes mean affordability of housing is actually a lot greater now than it was,” said Mr Winsor.

Unsecured lending, such as credit cards, tends to be affected more by factors such as unemployment than by rate increases. HSBC had 2m credit cards in circulation in India by the end of last year, up 60 per cent on a year earlier.

“We continue to see very good growth in credit card issuance,” said Mr Winsor.

Many banks are taking steps to mitigate the impact on borrowers. Rajiv Sabharwal, senior general manager, retail assets, at ICICI, India’s largest private sector bank, said banks were increasing the terms of loans for some borrowers to help cut their monthly repayments.

A slowdown in credit growth could cause a 10-15 per cent fall in real estate prices in some areas, he said. But he expected the economy to be able to absorb this.

“Demand is still strong, incomes are still growing, jobs are increasing, migration to cities is still going on,” Mr Sabharwal said.

That may be so, but for many Indian borrowers the coming year promises to be one of the toughest financially in a long time.