>India Banks (CITI)

INDIA BANKS

Rate Cuts = Stock Performance?

* Consensus appears to be positioned for a Repo Rate Cut — India's bond yields have been implying a reduction in policy rates for some time, recent weakness in economic data (GDP growth, inflation) has led to firming up of these expectations – both ours and consensus. Consensus is for a 50bps cut; we expect 100-150 bps (staggered over 1HCY09). But do rate cuts really drive stocks in the short term?

* Stock performance suggests policy rate cuts have minimal impact — Repo rate cuts have a positive impact on stocks – but only marginal. Banks have outperformed by an average +2% in 1 month post such cuts (PSU banks slightly better at +4%). Importantly in 3 of the past 4 instances stocks have outperformed 1 month before the cuts (underperforming 1 month after cuts) suggesting that the market has been increasingly efficient in anticipating possible rate cuts.

* CRR cuts also not a significant positive — Fundamentally, we believe the possibility of CRR cuts are relatively low given amply liquidity – in the system and on banks balance sheets. Even so, reduction in reserve requirements are likely to provide more operating gains (Higher NIMs; +5-6 bps for 50bps cut) than stock performance (+2% avg. outperformance post CRR cuts previously).

* Rate cuts: Impact on lending/deposit rates — Policy rates set direction for movements in lending/deposit rates, however, impact usually comes with a lag (1- 3 months). Currently ample system liquidity, slower growth and government talk has led banks to reduce loan yields ahead of deposit rates. Good economics suggest more aggressive deposit rates cuts ahead, which could be better for stock prices.

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