Rajan Successor Cheered as Stocks See Easier India Bank Clean Up

  • State-owned banks have beaten benchmark stocks since May
  • RBI seen lower borrowing costs, easing asset-review rules

India is due to announce a successor to central bank Governor Raghuram Rajan as early as Tuesday. To get a sense of what traders expect, look at bank stocks.

The NSE Nifty PSU Bank Index, which comprises 12 state-owned lenders, has rallied 20 percent over the past two months, as speculation about Rajan’s exit intensified. That compares with about a 10 percent gain for an index that also contains private banks and 8 percent for the broader NSE Nifty 50 Index.

The rally in state-run banks has gathered pace as traders speculate the next central bank governor may ease borrowing costs and asset reviews. Lenders have reported record losses as bad loans surged under a Rajan-led clean up, leading to allegations that his rigid rules and focus on inflation were stifling investment. In mid-May, a member of Prime Minister Narendra Modi’s party wrote to the government seeking Rajan’s ouster.

“From the U.S. to EU to China, wherever there is a bad-asset cycle, you cut rates, inject liquidity and stand as guarantor on all credit,” said Nikhil Bhatnagar, New York-based senior vice president for Asian equities at Auerbach Grayson & Co., a brokerage specializing in global trading. “I hope we will receive a pro-growth governor that will be very positive for the economy."

Two factors have aided the bank share surge, traders said: A broad consensus that the government will appoint a central bank chief who will boost growth before crucial state elections next year, and a comment from the head of State Bank of India, the nation’s largest lender, that the worst for the banking sector is over.

Bank of India shares have jumped 31 percent since May 12 and Punjab National Bank has surged 59 percent, the best performer on a gauge of India’s 200 biggest companies. Both were among 15 state-run lenders that reported combined losses of $3 billion for the March quarter as provisions for bad loans surged. The benchmark S&P BSE Sensex capped its biggest two-day advance since May 27.

"The current governor did a very aggressive asset quality review," said Nikhil Johri, chief investment officer at Mumbai-based Trivantage Capital Management India Pvt., which is buying certain state-run bank shares. The stock rally may continue if the new governor refrains from fresh reviews after the current one ends in March 2017, he said.

While looser monetary policy will make it easier for companies to refinance loans, it also risks stoking one of Asia’s fastest inflation rates. The government will also need to cough up as much as 2.3 trillion rupees ($34 billion) to recapitalize banks, according to estimates from Crisil Ltd., the local unit of S&P Global Ratings. That’s almost 10 times the amount Modi has pledged.

Emergency Funds

Arvind Subramanian, Modi’s top adviser, has proposed dipping into the Reserve Bank of India’s emergency funds for the cash. Other names doing the rounds include Arvind Panagariya, vice chairman of a government-established policy research group who favors lower interest rates, and Urjit Patel, one of Rajan’s deputies at the RBI who has helped establish an inflation target.

The decision on the next governor will be made after Modi returns from a foreign trip that ended Monday, a government official told reporters in New Delhi last week.

Rajan took charge of the central bank in 2013, when the rupee hit a record low and the inflation rate was among Asia’s fastest. After tight monetary policy and a crash in global oil prices helped damp price pressures, he began cutting borrowing costs last year and brought the benchmark rate to a five-year low of 6.5 percent.

While he played an "excellent role" amidst the global crisis, India now needs someone who understands the unique issues affecting the economy, such as supply bottlenecks that keep food costs high, said Gautam Sinha Roy, a fund manager at Motilal Oswal Asset Management Co. If that means going slow on the bank clean up, so be it.

"If the old policy of kicking the can down the road comes back, as an equity market participant, I won’t be too worried." Sinha Roy said.

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