How rising bank deposit rates could pose a challenge to the stock market - explained

 

Major benchmark indices forecast earnings to be around 15% higher over the next 12 months than at the beginning of 2020.

Dalal Street may face competition if banks start raising their fixed deposit interest rates to compensate savers

Indian equities usually command a premium. Even now, as investors are lowering their estimates of corporate earnings in emerging markets, they believe companies in the South Asian country will see reasonably healthy profit growth.

Following the recent downgrade, stocks comprising the country's benchmark Nifty index are projected to deliver around 15% higher earnings over the next 12 months compared to the beginning of 2020. This is when expectations for emerging markets as a whole have dipped below ex-ante. epidemic level. Is this expected improved performance worth the extra price?

Compared to other emerging markets, India's valuation gap is more than 3 standard deviations above the historical average, says Aditya Suresh, head of India research at Macquarie Capital. Not that global investors are shifting their portfolios to China's southern neighbor as they worry about the mainland's slowing economy and its growing isolation with the West. Although the selling pressure has eased since July, foreign fund managers have sold over $23 billion in Indian equities so far this year.

It is home buying that is giving a boost to equities. Where is the funding coming from? If you look at the overall picture of banking, the excess liquidity created by the central bank during the pandemic years has vanished. The Reserve Bank of India has increased its policy interest rate by 1.9 percentage points since May. Even so, the local stock market still hasn't been exposed to the full force of tight money.

Let's start with what brokerage HDFC Securities is calling the "changing nature of money transmission" in India. In March 2020, less than 10% of floating-rate rupee loans were priced lower than external benchmarks such as the RBI's repurchase rate. , By June this year, the figure had risen to 47%. Taking advantage of rising interest rates, lenders often reset loan prices.

When it comes to paying for deposits, however, they are still holding back. Domestic equity funds have seen straight 19 months of inflows. This is at least partly because banks are not providing fair compensation to savers in an environment of high inflation. Offer 5.85% on five-year fixed deposits by the country's largest commercial lender State Bank of India. This is when the current inflation rate is 7.4%, and the Indian government is paying investors between 6.3% and 7.5% to borrow for three months to 10 years.

Banks' rigor towards depositors is not only acting as a source of additional stock-market liquidity, but it is also providing an outlet. With assets revaluation faster than liabilities, HDFC Bank Ltd., the most valuable among Indian lenders, recently reported a 19% increase in its net interest income in the September quarter compared to a year ago. This is giving a boost to investors. An index tracking bank stocks on the Bombay Stock Exchange has returned nearly 15% so far this year, compared to a 2% gain - including dividends - for the Nifty index in local currency terms.

Can the country's banks continue to squeeze depositors like this? Loans and advances are up 16% year-on-year as economic activity rapidly returns to normal to its pre-pandemic levels, due to the way credit demand is created. However, systemwide deposits are only increasing by 9%. The divergence is largely on account of foreign currency outflows - official reserves have fallen by over $100 billion from their peak in September 2021 as the RBI tried to contain the rupee's depreciation against the dollar.

Should credit expansion continue at a rapid pace, India's banks may have to compete more honestly for liquidity by offering to pay better rates, indirectly driving capital away from the stock market and towards fixed deposits. should be encouraged. "This is the most important risk for Indian stocks in the next one year," says Macquarie's Suresh. Investors will look at fixed deposit interest rates to understand when tight money will hit the Indian stock market.