Finance minister P. Chidambaram with the Mexican minister of economy, Eduardo Sojo Garza Aldape, in New Delhi on Monday. India and Mexico have signed a 10-year bilateral agreement to promote flow of investment to both countries. Picture by Prem Singh

New Delhi, May 21: Real estate prices are likely to fall following the ban on external commercial borrowings (ECB) for integrated townships.

The government's argument is that if the rush of funds to the over-heated sector dries up, real estate prices will automatically come down.

Moreover, the finance ministry has lowered the ceiling on interest rates for ECBs, making it difficult for smaller companies to access funds.

“Now the window has been narrowed down. We hope that the flow of external debt to the real estate sector will slow down,” finance minister P. Chidambaram said today.

According to industry analysts, foreign funds have a major role in fuelling the real estate price spiral. A lot of money, through the debt route, has actually come in as ‘disguised equity’ and swamped real estate projects where prices have almost doubled in the past two years.

To cool down the over-heated real estate sector, the Reserve Bank had already winched up benchmark interest rates, making housing loans costlier. This obviously has made things difficult for home-loan seekers.

A property analyst said small developers, who lack the financial muscle to hold out against the trend, have reduced prices by 8-10 per cent. However, big builders are still holding their ground.

A leading banker said for the first time in three years developers have reduced rates to boost demand.

A nation-wide survey reports a drop in the rates by 5-10 per cent in the suburbs of Delhi, Mumbai and Bangalore.

Developers on the fringes of big cities have found it hard to hold on to the price line, the banker said.

“However, within the metros, the developers have withstood the plunge in sales, and prices in prime locations are still high.”

A senior income-tax official told The Telegraph that “the liberal laws for setting up overseas subsidiaries in tax havens could be one way through which realtors could still bring in foreign funds.”

The official said a company can float a subsidiary in a tax haven and issue preference shares to foreign investors. The subsidiary can then bring the money into India, circumventing the ban on the issue of such preference shares in the country.

Indian companies have raised $24 billion as ECBs in the last fiscal, higher than the cap of $22 billion.

The huge inflow of dollars has also raised the money supply which has pushed up the inflation rate.

Meanwhile, the RBI today issued a notification banning real estate companies from raising funds through the ECB route for developing integrated townships, while revising interest rate limits for those who are allowed to tap the overseas markets.

Pre-IPO equity sale

The government is having a relook at the policy of pre-IPO sale of shares by real estate companies to foreign investors. This could see the private placement of equity being classified as investments by financial institutions.

“The department of economic affairs and department of industrial policy and promotion have come around to the view that the pre-IPO sale of shares by real estate companies should be given the status of FII investment,” sources said.