Vikas Sharma Q-45
roll no 1273665
Indian Banking: Outlook for
2014
Introduction
Raghuram Rajan’s big challenge in 2014 will be building on the gains he’s scored
since taking the helm of India’s central bank last fall.
The rupee was among the world’s worst-performing
currencies in the summer, losing more than 20% of its value against the U.S. dollar
between May and August, reflecting a rush of capital out of emerging markets.
India, which runs large trade and budget
deficits, depends on foreign capital to meet its financing needs. When
foreign investors sensed U.S. rates were heading higher, they moved out of
Indian stocks and bonds.
Mr. Rajan managed to stabilize the currency and
buy time by taking innovative steps to attract capital back to India. A program
to attract deposits from non-resident Indians, for instance, raised $34 billion
in foreign exchange reserves, far more than analysts had expected.
He also took the tough decision of raising
interest rates at a time when economic growth was already slowing sharply. The
rupee is now trading close to 60 per U.S. dollar, up from lows just short of 69
in August.
But many analysts say India could face new
headwinds now that the U.S. Federal Reserve is winding down
its $85 billion in monthly bond purchases, pushing U.S. interest rates higher.
Mr. Rajan told reporters in mid-December that
India is better prepared now than in the summer to weather the Fed’s moves,
though there could be some volatility in the local markets.
Meanwhile, India’s economic health remains
precarious. Inflation has been rising, fueled by a spike in food prices and the
rupee currency’s fall earlier in the year.
Mr. Rajan has said he’s committed to taming
inflation and has raised benchmark interest rates twice since he took over. The
central bank held rates steady in mid-December, saying a recent flare-up in
inflation driven by food prices could be temporary. Mr. Rajan said the bank
didn’t want to react to short-term price increases.
Analysts will be watching to see whether Mr.
Rajan will be able to stick to a hard line on inflation and raise rates further
in 2014, even if the economy slows.
Economists expect India’s economy to expand by
less than 5% in the year that ends March 31, the slowest pace of growth since
2003. The government is also pressing for lower rates to stimulate the economy,
ahead of federal elections due before May 2014.
Another thing to watch for in 2014: The central
bank is expected to hand out licenses to allow new private banks, a move aimed
at boosting competition and bring more financial services to rural India.
Discussion
Rating
agency Moody’s has maintained its negative outlook on India’s banking
system, reflecting the effects of the rupee’s volatility, persistent inflation
and slowing economic growth.
In a statement, Moody’s said asset quality would continue to deteriorate,
particularly for public sector banks (PSBs),
while profitability was likely to remain weak, limiting internal capital
generation.
Moody’s rates 15 banks in India— 11 public sector banks and four private sector
banks. It also incorporates government support in the ratings of all these
banks.
Conclusion
Having already made new highs during 2013, I
believe, going into 2014 equity markets are likely to be positively poised on
the back of supportive global cues as well as improving domestic outlook. The
markets have taken the announcement of moderate tapering of the Fed’s QE3
program in their stride as India’s external sector risks have materially
subsided. A gradual tapering of monetary stimulus by policymakers indicates
confidence in the economic recovery taking hold in the United States. In the
medium-term, a revival of growth in advanced economies is beneficial for export
demand from emerging economies like India.
Strong export growth,
aided by the sharp rupee depreciation, as well as recovery in external demand,
are key factors for improvement of the domestic outlook as it has reduced
India’s external vulnerability and is positive for GDP growth. Coupled with
this, India’s resilience on the external sector has also stemmed from a
compression of imports, driven by restrictions on gold imports. Driven by these
aspects the current account deficit has come down sharply at 1.2 per cent of
GDP in Q2 FY2014 as against a wider deficit of 4.9 per cent of GDP in Q1
FY2014. I expect improvement in the trade balance to continue with the deficit
moderating closer to a more sustainable level of 2.5 per cent of GDP for FY2014
compared to 4.8 per cent in FY2013. At the same time, a pick-up in banking
capital, NRI deposits and debt inflows on the back of measures announced by the
RBI have rendered financing of the deficit more manageable.
High inflation remains
the key overhang on the outlook as WPI- and CPI-based inflation have paced
higher. But on the positive side, it is driven largely by a surge in vegetable
prices, seen to be temporary in nature. I feel, vegetable price inflation will
moderate in the near future. Recently, the Government has indicated at policy
prescriptions to combat the rise in vegetable and fruits prices. Going forward,
on account of the improvement in agricultural production, food prices are
likely to moderate and ease inflationary pressures to that extent.
Markets are hoping for
a strong show by the BJP-led Government in the general elections owing to their
pro-development and reform agenda. If that happens over the coming six months,
then the market momentum would strengthen, benefiting stocks in the cyclical
sectors. Given India’s demographics, any new Government would focus on revving
up the economic growth engine and creating more job opportunities for the
youth. Post-elections, greater policy certainty could drive announcements of
new projects and revive the investment cycle, both of which would invigorate
GDP growth.
In the light of these
positive developments, I expect Sensex EPS to post a robust 17-18 per cent growth
in FY2015, higher than the 9-10 per cent growth expected during FY2014.
Attributing a 16 times multiple to the Sensex EPS, we arrive at a Sensex target
of 24,600 for the coming 12 months. Beyond this, I believe markets are likely
to, at least, give returns in line with the expected 13-15 per cent earnings
growth.
Despite strong
interest evinced by foreign institutional investors, retail investors have
shied away from equity investments owing to the market’s underperformance in
these past five years. It is only a matter of time before the investment
environment in the country strengthens, resulting in a broad-based pick-up in
economic activity and rise in market participation.
I would continue to
recommend investors to remain positive on the outlook for export-oriented
sectors, such as IT and pharmaceuticals. I’m also overweight on select metal
stocks, considering the recent capacity additions and under-utilised capacity
getting employed for exports as global fundamentals improve. In the light of
positive cyclical factors shaping up, I prefer select large private banks, as
they continue to remain structurally strong and could benefit from an imminent
economic recovery.
