Bangalore Real Estate Trends

Home loan interest rates will begin to ease once the high inflation rate comes under control. Vikas Agarwal explains the effect of inflation on interest rates

Inflation is a buzzword you hear almost everyday. In India, the broad-based inflation rate is published every month, based on the Wholesale Price Index (WPI). The WPI measures the prices of a basket of goods and services, and the inflation rate is the percentage rise in the WPI during a given month. The other major index that is regularly tracked is the food inflation index. The food inflation rate is reported every week based on the prices of a basket of commodities.

The high inflation rate is not just specific to India. Inflation has been ruling high in all emerging markets ever since the global economy came out of recession last year. There are several factors that resulted in the high rate of inflation in the markets here including demand-led factors, supply-led factors and the price rise in global commodities.
The initial wave in inflation was fuelled by rising prices of food articles due to deficit and delayed monsoon in several parts of the country (demandsupply factor). Later, it was driven by high liquidity, rising prices of global commodities and crude oil (global factors). The trend of rising prices spread to other significant constituents such as manufactured goods and non-food articles (cascading effect). This provided the next set of triggers for the inflation rate to move up.

It is important to note that controlled inflation is good for the overall economy as it works as an incentive for economic activity. In India, the mandated and targeted range for inflation is around 5-5.5 percent. The target is set and decided by the government and the Reserve Bank of India (RBI). If the inflation rate goes beyond this level and stays there for few weeks, it calls for analysis and subsequent actions by the government and RBI, because uncontrolled and high inflation is actually destructive for a country as consumers and investors change their spending habits.

The government's actions to control the inflation rate include temporary ban on exports of selected food items, control on price of fuel etc, while the RBI tightens the monetary policy by raising the cash reserve ratio (CRR) as well as the key interest rates. In simple terms, a monetary policy tightening results in reduced supply of money in the banking system. A tight money supply results in tougher norms for loan disbursals as well as higher interest rates on various loan products. The overall money availability gets tighter in the system. This helps in controlling aggregate demand and brings the inflation rate down.

Higher interest rates are detrimental to growth in the economy as they increase the cost of money for individual as well as corporate borrowers. Therefore, the RBI has effected the interest rates hikes in a staggered manner (in small steps) to ensure a gradual hike in the interest rates in the system. The RBI has already raised the interest rates seven times over the last 18 months. The policymakers are ready to compromise on economic growth to some extent to deal with the rising inflation rate because the implications of a high inflation rate are quite widespread, especially for the economically weaker sections of society.

To find out which way the inflation rate is headed, these are some of the major factors you need to track:

Fuel price

The price of crude oil is trading over 100 dollars per barrel in the international markets. Although the petrol price has been increased in the recent past, the government has avoided a hike in diesel, kerosene and LPG prices by absorbing the subsidy burden. Analysts believe if the crude oil price continues to trade over 100 dollars per barrel in the international markets the government will be forced to hike the price of retail fuel in the domestic market again. This will add to the inflation rate due to the ensuing price rise effect.

Global factors

Global factors such as expectations of a slowdown in demand from China in international commodities, Europe's debt crisis and the soft monetary policy in the US can weigh on the prices of international commodities. This, and speculation in the commodity markets, can add to the inflation figure.

Monsoon

The monsoon is always an important factor here. A weak monsoon can result in lower farm yields and thereby increase the upward pressures on commodity prices.

Rates yet to peak

Going by the current situation, analysts believe the interest rates have not yet peaked, and it will take a couple of rounds more of interest rate hikes in the short to medium terms by the RBI before the inflation rate comes under control. Although the inflation rate has started showing signs of weakness, the hike in fuel price will keep it upbeat in the near future.

Once the inflation rate comes under control you can expect a peak in the interest rate cycle, and subsequent easing in interest rates on home loans.

QUICK BYTES

EVER SINCE THE GLOBAL ECONOMY HAS COME OUT OF RECESSION, INFLATION HAS BEEN HIGH IN ALL EMERGING MARKETS ACROSS THE GLOBE

CONTROLLED INFLATION WORKS AS AN INCENTIVE FOR ECONOMIC ACTIVITY AND IS GOOD FOR THE ECONOMY

_{Source: Times Property Dt: 10-06-2011}