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Inflation: What about banks? - Views on News from Equitymaster
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  • Aug 10, 2004

    Inflation: What about banks?

    The rise in inflation has proved to be a bane for major PSU banks, which have been rendered poorer by nearly Rs 80 bn on account of growing yields and the resultant declining bond prices (as bond prices are inversely related to yields). The high inflation of 7.5% comes as a bad news to the banks for more reasons than one.

    Let us look at the various factors that are likely to affect the banking stocks going forward.

    The flip side

    Investments: Major PSU banks have more than 40% of their net deposits and time liability (NDTL) invested in government papers of varying maturities and coupon rates. This investment build up in government securities is largely due to lower credit offtake in the last fiscal coupled with attractive coupons and returns being offered on the back of softer interest rate regime. As a result, unrealized income of banks witnessed robust growth in FY04. However, since the end of FY04, the yield on benchmarked 10-year paper has increased by more than 100 basis points resulting in erosion of investments in value terms. Just to put things in perspective, SBI's (India's largest bank), other income, which is about 20% of its operational income, has declined by 12% during 1QFY05.

    Banks other income
    Other income (Rs m) 1QFY04 1QFY05 (%) Change
    SBI 17,529 15,387 -12.2%
    Oriental Bank 1817 998 -45.1%
    Corporation Bank 1257 1001 -20.4%
    HDFC Bank 1322 1080 -18.3%
    IDBI Bank 428 417 -2.6%
    UTI Bank 1503 1101 -26.7%

    Non-food credit offtake: The credit scenario has now been looking up for the last few quarters. Infact non-food credit picked up by 17.6% in FY04, while a steep fall of over 27% was witnessed in food credit. Housing and retail (consumer durables) lending have emerged as the new growth drivers for non-food credit offtake for banks. As interest rates rise (which is likely to happen soon), it is likely that consumers postpone spending on such dear items. To put things in perspective, credit for housing grew by 42% YoY. This growth stood at 55% during FY03. Housing and consumer durables lending alone account for nearly 8% of the total non-food credit.

    Retail offtake growth
      FY03 FY04
    Housing 55.1% 42.1%
    Consumer durables -1.6% 14.6%
    Real estate loans 19.3% -5.4%
    Tourism 17.3% 34.6%
    Individual loans 15.9% 0.9%
    * Source: www.indiabudget.nic.in

    Capital-intensive projects: A northward shift in interest rates is likely to result in major capital intensive projects being postponed or shelved as the IRR (internal rate of return) on such projects would turn out to be less attractive or negative in some cases. Various corporates (public sector as well as private) have lined up huge investments in power, refining and steel capacities, which could be negatively affected in case cost of financing these activities increase.

    Bank credit
    Credit offtake FY03 FY04 1QFY05
    Food credit -8.3% -27.3% 19.7
    Non-food credit 28.4% 17.5% 4.4
    * Source: www.indiabudget.nic.in
    * Source: http://finmin.nic.in

    The upside
    The government has committed to double agricultural credit over the next three years. We can already see a growth of nearly 20% during 1QFY05 in food credit. This is a key positive for the economic growth of the country in general as nearly 70% of the working population depends on the agricultural sector for occupation. The non-food credit has grown at a slower pace of 4% YoY during the quarter. However, the fact that 6 power projects have achieved financial closure and also 10 power projects are in the pipeline augurs well for the banking industry. We believe robust economic activity in terms of infrastructure development and irrigation projects (Rs 300 bn being lined up for water projects and Rs 400 bn being set up for further infrastructure investments) shall provide the much-needed fillip to non-food offtake going forward.

    Net, net the strengthening of interest rates is to be viewed with caution. If interest rates were to rise steeply, a lot of pessimism could filter down to the Indian equities.



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