Indian markets had a poor start to 2011. The first week of the year saw the BSE-Sensex lose 4%, even as most other key global markets closed with good gains. India's weakness was largely a result of pressure on auto and banking stocks. While the BSE-Auto index dropped by 7.3%, the BSE-Bankex declined 6.5%.
Let's talk about banking stocks here. The sell-off in these stocks was seemingly a result of the fears of further interest rate hikes by the RBI. India's inflation is not showing any signs of cooling down. Instead the monster is just growing in size. Just last week, food inflation came in higher at 18.3%. This was a sharp 4% higher than the inflation figure that came earlier than this. Vegetables, food grains, fruits, you name it and the prices are surging.
This is adding to the RBI's concerns that stem from rising prices of commodities like crude oil. So there is a general fear that the central bank will announce an interest rate hike sooner than later. An interest rate hike, or a tightened money supply – both go towards reigning in inflation – will have an adverse impact on India Inc. This is especially given that a lot of companies are going for large scale capacity expansion. As such, any further rise in borrowing costs will spoil the party for them.
Another concern that surrounds investors in banking stocks is their valuations. After the rise seen last year, and in face of the current problems, these do not have much headroom to go up from here on. At least the fundamentals do not justify the same. With little upside in margins, banks are expected to rely heavily on their fee income generating abilities in addition to their operating leverage.
Also, most banks envisage higher loan restructuring and provisioning costs in the next financial year (FY12, which starts in March), which may eat into their profits. So, buyers of banking stocks need to be very careful about the choices they make.