Market betting on short term gains for banks

The banking and finance sectors have responded with large post- Budget gains. The Nifty Bank is up by over five per cent since Monday. From a technical standpoint, the signal is clear. Any trend following system will suggest going long and staying long, with a trailing stop- loss.

Easing liquidity in the bond market and the hopes of more rate cuts from the Reserve Bank of India ( RBI) have driven the rally. The bond market went into a big rally on Budget day, with yields falling sharply. The reason was a positive surprise.

Nobody expected the fiscal deficit to be held to 3.5 per cent of GDP ( gross domestic product). The governments borrowing programme in 201617 will be somewhat less than in 2015- 16.

There are also hopes RBI will cut rates in early April, at its next bi- monthly policy review. Some optimists are hoping for an earlier rate cut --- after all, RBI made an out- of- turn rate cut in 2015. I am not so sure RBI will cut rates, either out- of- turn or in April. Retail inflation in January was running at 5.69 per cent year- on- year ( y- o- y). Given projections in a range of 4.5 per cent to 5.5 per cent this financial year ( according to the Budget) and a target of five per cent by January 2017 ( according to RBI), there is not much room for instant rate cuts.

The market is betting on the short term. Even if nonperforming assets ( NPAs) remain uncovered, and net worth is dangerously low on some public sector bank ( PSB) balance sheets, that is a longterm problem. In the short term, there is better liquidity.

The Budget did disappoint in one important respect. The recapitalisation allocation of Rs.25,000 crore is much lower than required to put PSBs back on a sound footing. Close to 10 times that amount may eventually be required.

PSBs may come under even more stress this year given that they will have to lend more under the expanded agricultural lending programme of Rs.9 lakh crore. However, there is a possibility that some " sticky assets" in stalled infrastructure projects will become recoverable.

There are other positives.

One is that the bond market rally has led to capital gains in the portfolios of banks holding treasuries. Second, RBI has changed capital adequacy rules to allow banks to count the value of their land holdings ( at 55 per cent of current value, after revaluation) as part of Tier- 1 Capital. In addition, " forex translation reserves" and deferred tax assets can be counted as Tier- 1, subject to discounts.

Forex translation reserves arise from translation of overseas operations into rupees. This easing of rules could ramp up PSB tier- 1 capital by Rs.35,000 crore or more. Tier- 1 capital is owned funds consisting of equity and reserves. Lending is limited by the Tier- 1 quantum. India is committed to meet Basel- III international banking norms, which demand higher Tier- 1 Capital in time- bound fashion. Allowing land, forex translation, deferred tax assets, etc, to count as Tier- 1 takes some pressure off the government of India, which has to shore up its equity holdings in PSBs. It also allows PSBs to expand credit.

But, this doesnt compensate banks for losses on bad loans. That money still has to be provisioned and it remains a potential time- bomb. We dont know if this will explode at all.

The Nifty Bank is less affected by PSB woes because private sector banks have much higher weights in the index and private banks dont have such problems. But, if theres a problem in a big PSB, it will affect the entire sector. But, as of now, traders continue to ride the uptrend.

Business Standard, New Delhi, 3rd March 2016

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