While foreign investors seem to be making a beeline for property in India, HDFC Chairman Deepak Parekh believes real estate is overpriced. He speaks to Shobhana Subramanian on the dangers of having unreasonably high property prices, saying affordability is now being stretched. Excerpts:

You haven't been bullish on real estate. What do you think you've missed?

I'm still not bullish. Real estate in India has to do with affordability whether it's for residences, offices or even malls, and affordability is the key to viability.

The boom in the commercial space is due to the demand from the IT and ITES sectors where most companies don't buy space. Almost 90 per cent of it is rented. Companies cannot afford to pay rents of Rs 30-35 per sq foot because the wage structure is increasing. If you don't want to lose business to China or Vietnam, rents have to stay in check.

How many malls can afford to pay Rs 100-150 or Rs 200 per sq foot? Look what happened to Crossroads. Only restaurants are left because food sells and the Piramals have sold out. The same thing is going to happen to other malls. There are many international brands, but they too cannot afford to be present in every mall.

How do you view property prices today?

I was in Bangalore recently. Developers tell me they see a slowdown in sales and a dip in commercial and residential property prices varying between 10-30 per cent in Whitefield, which is a growing suburb. I would say this is the beginning, it's not a bubble.

A correction is necessary and further increases are unlikely to happen. Even if your cost of construction goes up, you will not be able to pass it on because you have inflated land prices.

Home loan rates have risen 200-250 basis points from their lows 30 months back and asset prices are also up. Is affordability deteriorating?

Affordability is certainly at a stretch. But the shortage of housing is enormous, so we feel that a 200 basis point increase in home loan rates will not impact demand for housing.

Normally, we either extend the term of the loan, or increase the EMI or ask people to make balloon payments. Sure, we don't want the loan period to extend. Some of the banks have started disbursing loans at 25-year periods at origination. These loans will easily stretch to 40-45 years. Can we afford this? We have to lend on cash flows of the family, not on the asset value.

Interest rates are up 150 basis points year-to-date, though the 10-year benchmark yield has gone down 100 basis points in the last six months. What is your take on interest rates?

Liquidity is certainly getting tight, but then CRR has just been increased and advance taxes have just been paid. Corporate tax collections are 64 per cent higher this December compared with last year. So, the rise in short term rates is temporary and should ease, I would say, by the end of January.

As for long-term rates, I don't think that with the 10 per cent growth that we are aiming at, we can contain inflation below 5-6 per cent. In which case interest rates have to go up and I would imagine a rise of between 1-1.5 per cent.

For the hundredth time, why aren't you merging HDFC Bank and HDFC? Is the Rs 15,000 crore SLR tab the only issue?

The tab is now Rs 20,000 crore (Rs 200 billion).

What about the holding company structure, which you have been talking about?

There is an issue with the double taxation on dividends, which some groups have said, should go. Also, the withholding tax is no longer small, it's very high.

So the operating company pays dividends, the holding company pays withholding tax and even if it's a pass-through, the same amount is paid. There's been a request that if it's a pass-through, to the extent that the holding company pays more, charge it for withholding the tax on dividends.

For instance, if it receives Rs 100 and pays Rs 90, then charge it. But if it receives Rs 100 and pays Rs 200, then charge it on the balance amount.

There are other issues too. We already have two listed companies and are planning to list our insurance ventures soon. A holding company must be listed, so it becomes messy in our case because there is no family. Who will hold the shares?

You say size and market cap are very important for financial players, yet you desist from consolidation. Also, compared with ICICI Bank, don't you think HDFC Bank has grown slowly?

Yes, size is very important but we are growing at a minimum of 30 per cent every year. I think in the financial sector, growing at a 50 or 100 per cent rate on a per annum basis, is inviting trouble in the future. You must have a reasonable growth. A finance company cannot double and treble its balance sheet. Thirty per cent is much more than we can handle.

How does one interpret the 12 per cent stake that Citibank holds in HDFC? Isn't Citibank a competitor?

Standard Life needed to sell the stock and I'd say it's a sale from one portfolio investor to another. Citibank is a competitor in only banking, not in insurance or asset management. Besides, we have 500 branches, while they have 50, so where is the competition?

Citibank is one of the largest lenders to our mortgage business. They are also distributors to our AMC. We work closely, so I don't think you can view Citibank as a competitor.

Do you foresee a time when Citibank will take over HDFC Bank, legislation permitting?

We don't know what the future holds. One thing is certain: as an individual, I can't prevent anything because I don't hold any stock that has power.

HDFC will launch a $750 million international real estate fund next month. How big is the opportunity in this space?

We'll close the fund by January or February. We see an opportunity in real estate if one invests wisely. I know that on the one hand, I'm saying real estate prices are too high and on the other, we're raising money for real estate equity investment.

But our case is different. We have been working with developers for 29 years and have supported many of them with construction finance. We have an edge over the others because we can request our old clients for a project in which we can take an equity stake and thereby, hold a better chance at succeeding.

The other advantage we have is that every builder requires debt, and he knows that if we give him equity from our fund, we will provide debt in any case, because we become part owners of that project. Having said that, we have to be careful about land valuation and we will not accept inflated valuations.

Should the government sell UTI Mutual Fund?

It does make sense because there are five shareholders and each of them have their own AMC and are competing. Five owners are too many and LIC has its own portfolio, so there are some conflicts. Maybe one of the five can make a bid for it. It need not go outside the family of shareholders.