RBI fears realty bubble

The government's proposal allowing housing finance companies and non-banking finance companies to access overseas markets for raising funds is up for review.

This follows concerns raised by the Reserve Bank of India on usage of foreign funds in the real estate market. According to government sources, the final circular allowing HFCs and NBFCs to access overseas funds through foreign currency convertible bonds or external commercial borrowings will need to be fine tuned and may take some time.

According to the sources, the RBI has sought clarification from the government on inclusion of proper safeguards before allowing these companies to access foreign funds.

The regulator's main concern is that too much foreign funds flowing into the real estate sector might give rise to an asset bubble as seen in the South east Asian crisis in 1997.

It has suggested the safeguards must ensure that the foreign funds flow into long term infrastructure projects like development of townships etc. In other words, the funds should not be used for buying real estate and create an asset bubble by rapid increase in prices.

Explaining the concern, sources said, since prepayment of ECB/FCCB is allowed, overseas investor or lender of funds might exit after one or two years asking for prepayment of the funds even if the maturity period is for five years.

This will ultimately result in an increase in short term debt of the country without the institutions actually investing in short term assets.

RBI has further proposed that banks which will be responsible for the ultimate drawdown of the funds after the ECB is sanctioned should scrutinise the end use of funds. Earlier, the RBI was apprehensive of allowing HFCs/NBFCs to borrow overseas as the domestic liquidity was enough.

Even then, finance companies preferred to tap the overseas market for interest rate arbitrage. This means they will borrow funds at a lower rate and invest it in India at a higher rate.

While domestic liquidity was lying idle, the overseas borrowing was adding to the liquidity as dollars have to be converted into rupees.

This in turn was posing additional problem for the RBI to manage the liquidity, which was increasing with incremental foreign exchange inflows and reserves.

The government in the first week of June, had eased the ECB norms by allowing non-banking finance companies and housing finance companies to raise money in the overseas market.

They were banned from accessing the overseas market for resources by the ministry a few years back.