11 October 2004	Monday	25 Shaban 1425

Rapid increases in real estate prices in the past used to upset all costing projections of commercial builders as well as of individuals who sought housing loans.

If prices remain stable, bank financing should suffice their rightly projected requirements.

The State Bank decision to refrain banks from financing mere purchase of land is rooted in the realization of the fact that speculation in real estate is a key contributor to inflation. By requiring banks to finance purchase of land only for construction on it, SBP wants to contain speculative buying of land and thus stabilize real estate prices.

There is no denying the fact during a year or so most of the land purchased was not used for construction. This is evident from slower growth of metal industries in the last fiscal year.

In July-June 2003-04, metal industries grew by only 2.2 per cent, far less than 9.8 per cent in July-June 2002-03. Had people used the land purchased during this period and a bit earlier for construction, metal industries' output would have been much higher. The reason is that the products of these industries are widely used in construction industry.

In fact, production of HR sheets and strips; CR coils, plates and sheets, all of which are used for making iron bars and other materials used in the construction industry declined in the last fiscal year.

The output of HR sheets/ strips fell by 8 per cent to half a million tonnes and that of CR coils/ plates/sheets declined by less than one per cent to nearly 191,000 tonnes.

Some say that the SBP decision may cause a slump in the housing sector activities in the short term. They say it would hurt not only speculators but also those genuine buyers who were planning to buy land out of bank financing without an immediate plan to use it for construction.

But a general feeling is that in the long run the SBP move would help the housing sector grow. As the move leads to freezing, or even reduction in the prices of real estate, serious investors who are all waiting for this, would start pouring money into the housing sector.

In case the move does not lead to freezing of or reduction in the real estate prices it would stabilize them i.e. it would block price flare-ups with short intervals.

That alone would be a big relief for genuine investors and people planning to buy land and construct houses thereupon. Rapid increases in real estate prices in the past used to upset all costing projections of commercial builders as well as of individuals who sought housing loans. If prices remain stable, bank financing should suffice their rightly projected requirements.

Many such investors have enough money and they would borrow from banks only to supplement their own resources. So, now banks would see a moderate demand for housing finance but that would come forth from the top clientele having the capacity to repay.

Such serious loan seekers would also be willing to pay higher mark-ups on housing finance. Housing finance would become costlier in the months to come in the wake of an overall upward adjustment in interest rates.

In July-September 2004, the central bank raised the weighted average yields on treasury bills of three-months, six-months and one-year by 125bps, 93bps and 78bps respectively.

The weighted average yields on long-term government bonds, ideal for bench-marking housing loans, also seem set to rise from the last-seen levels of 9 per cent for 15 years and 10 per cent for 20 years.

The banks that were making housing loans on fixed mark-up now find it difficult to maintain them because of gradual hiking of interest rates by SBP to contain inflation. Marginal inflation in July-August 2004 was 9.29 per cent, enough to irk economic policy makers who are struggling to keep the full fiscal year inflation at 6 per cent, still higher than the initially targeted 5 per cent.

An increase of 9.6 per cent in house rent was the second largest contributor to 9.29 per cent inflation in July-August after 14.35 per cent increase in the prices of food & beverages.

House rent is directly proportional to prices of real estate and housing units. So, a decrease in real estate prices would also decrease house rents and contain inflation. Besides, the likely fall in the real estate prices as a result of reduced demand would lower inflation through a cyclical reduction in prices of various goods and services.

Initially, during the period when housing sector activities may slump in the wake of the SBP decision of restricting housing finance, some housing-related industries may be affected. But after a while, when construction activities restart, this slump would be more than compensated by an accelerated growth of all housing-related industries. While directing the banks to provide housing finance for land purchases only for construction on it, the State Bank has also required them to release funds in tranches.

It has told them that up to 50 per cent of the loan limit should be disbursed for land purchase and the remaining 50 per cent for construction thereupon. The central bank has also warned banks to sanction housing loans only after assessing the repayment capacity of the borrower, the value of land and the cost of construction.

This may add to the problems of ordinary people seeking loans for construction of housing units. The reason is that assessing their capacity to repay would become too difficult and quite controversial in cases where they have no history of dealing with banks.

On the other hand, speculators may still manage to get bank finance for mere purchase of land. They may do this by getting the value of the land they want to buy and supposedly construct a housing unit on it, assessed at artificially high rates. Here, the role of professional value assessors on the panel of the banks would be of prime importance.

The top management of the banks must ensure that the SBP decision is executed in such a way that it discourages speculators but does not create troubles for genuine loan seekers.

Personal finance: While stopping banks from financing mere purchase of land, the central bank has also allowed them to raise the limit of personal finance from Rs0.5 million to Rs2 million. SBP has apparently taken this decision to offset an adverse impact of its first decision on the banks in particular and on the entire economy in general.

When banks would stop mere financing of land purchases, the resultant fall in their credit offtake, though not very significant, would be compensated by an increase in personal finance volumes.

Similarly, a boom in consumers spending backed by faster growth in personal finance would also offset the economic cost of an initial slump in the housing industry.

The volume-wise growth of personal finance has already been higher than that of housing finance, which substantiates the view that an increase in personal loans should well compensate a fall in housing loans. During March-June 2004, personal loans grew by Rs9.6 billion but housing loans grew by only Rs2.8 billion.

Stock market: As the banks stop providing loans for mere purchase of land, those who used to seek such loans and use part of their own resources to buy land only to resell, may turn to the stock market. If they stop borrowing from banks, they can still use their own resources for making investment in the stock market that is in need of a big support.