Markets
Lower fiscal deficit to drive banking sector rally
Summary
- Lower-than-expected fiscal deficit cheered bank stocks as cost of borrowing reduces
The vastly lower fiscal deficit of 5.1% budgeted by the Centre for the next fiscal year was the catalyst for an outperformance of banking sector to benchmark and other sectoral indices as this lowers the trajectory for bond yields. Among the banks, the National Stock Exchange’s 12-constituent Nifty PSU Bank index outperformed the benchmark 50-stock Nifty, the Bank Nifty, as well as the BSE’s benchmark Sensex and other indices by a wide margin after the finance minister’s interim budget presentation on Thursday. The benchmark bond yield too traded lower.
The outperformance was reflected by the Nifty PSU Bank index closing 3.11% higher at 6,466.45 against the Bank Nifty’s 0.42% gain at 46,188.65, and the Nifty and Sensex closing down by over a tenth of a percent each at 21,697.45 and 71,645.30. Analysts expect the outperformance to persist in the near term—if the Nifty falls, the Bank Nifty and PSU Bank index will fall less, and if the gauge rises, they would rise more.
The reason is the gap between the government’s spending and revenue— fiscal deficit—projected to narrow in the next fiscal year (FY25) due to higher tax collections. This means the government will have to borrow less and thus bring down the cost of money for the private sector. Gross borrowing is pegged at ₹14.13 trillion in the next fiscal against ₹15.43 trillion in the current fiscal. Net borrowing is estimated at ₹11.75 trillion, versis ₹11.8 trillion last year. This will mean lower investment by banks, especially state-owned ones, in government bonds than they do at present as the government borrows to fund the deficit.
The government estimates tax receipts to grow by 11.96% year-on-year to ₹26.02 trillion in FY25.
The statutory liquidity ratio, or the proportion of deposits banks must invest in government bonds, is 18%, but lenders, especially PSUs, normally invest 28-30%. The lower targeted deficit means this excess portion can be freed up for lending to industry. It also means banks will make treasury gains due to falling bond yields over time, which the market could begin pricing in.
The fiscal deficit for FY25 has been budgeted at 5.1%, substantially lower than the 5.4% expectations of the market. The fiscal deficit for FY24 has been pruned by 10 basis points to 5.8%. A basis points is one-hundredth of a percentage point.
“The lower deficit target is positive for banks and among them state-owned lenders, which tend to invest more in g-secs than the mandated 18%," said A. Balasubramanian, managing director, Aditya Birla Sun Life Asset Management Co. “As the Fed (US Federal Reserve) cuts rates this year, and the RBI (Reserve Bank of India) follows suit, bond yields will fall and this will be directly visible in the PnL of banks."
However, not everybody is as sanguine as Balasubramanian, terming it rather aggressive.
“The fiscal deficit target for FY25 seems aggressive," said Shankar Sharma, founder of wealth management firm GQuant Investech. “This is predicated on an aggressive revenue growth, and if that doesn’t play out to plan, the government will have to scale back capex to meet the fiscal deficit target and that’s where the markets will be concerned."
Sharma feels that the Sensex and Nifty could be close to making an intermediate peak and that the India story remains a small-cap one. The reason for tepid large-cap growth is the nominal gross domestic product (GDP) growth of 10.5% projected for FY25. If that’s the peg, there’s no way that corporate earnings will grow higher, he explained.
Nominal GDP growth (at current prices) for FY24 was also estimated at 10.5%, but is expected lower at 8.9% with the rest of it being the deflator, which measures the change in prices.
Andrew Holland, chief executive officer of Avendus Capital Public Markets Alternate Strategies, described the interim budget as “pretty credible" and said that markets would now take cues from the RBI’s monetary policy committee’s meeting on 6-8 February.
“The fiscal rectitude will be good for banks and control in government borrowing will help keep bond yields lower, which will also impact borrowing cost for the private sector favourably," Holland said.
The benchmark 10-year government bond yield ended 8 basis points lower at 7.06%.
Madan Sabnavis, chief economist at Bank of Baroda, added that while the RBI rate setting committee would hold the policy rates at its upcoming meeting, the trajectory for bond yields would turn lower in the future especially when the RBI begins to cut rates.
Some of the top banking gainers on Thursday included Bank of Baroda ( up 3.37%), Punjab National Bank ( 3.88%), Union Bank ( 3.4%) and State Bank of India (1.11%).
