Lower tax rates won't change fundamental concerns for banking stocks

For the second consecutive trading day, Indian equities cheered the government’s move to reduce corporation tax for India Inc. Banking stocks, in particular, seem to have benefitted the most. With a jump of over 5 per cent on Monday and 14 per cent since last Friday, the Nifty Bank index stands out as the largest gainer. 

Part of these gains could be correlated with the fact that most brokerages believe the lower tax rate could strengthen earnings and the return profile of banks. For instance, analysts at Nomura say banks could see their earnings increase by 10–13 per cent, with a near 10 per cent moderation in the corporation tax rate. This could, in turn, lift the return profile of banks, with return on equity increasing 1–1.5 per cent for the sector.

However, what needs to be seen is whether the current fundamentals are supportive enough to help meet these heightened expectations. For one, data on loan growth, including for August doesn’t paint an encouraging picture. The appetite for loans, whether corporate or retail (barring personal loans), isn’t healthy. Offtake in the retail loans segment started weakening since July and remains so even in August. 

Suresh Ganapathy, banking analysts at Macquarie Capital, in a note based on a marketing trip to Singapore and Hong Kong, said investors seemed fairly pessimistic on banks after the recent slowdown in GDP growth and noise surrounding job losses. These being the guiding factors for loan growth exhibiting little signs of recovery and experts say the reduction in the corporate tax rate may not reverse these conditions. Analysts at Kotak Institutional equities echo the opinion. “We expect earnings for banks to largely remain unchanged,” they say. In the case of large banks, they feel, in order to remain more competitive, banks could cede part of their net interest margin, as seen in the past, to spur loan growth. “We expect higher competition in lower spread products,” analysts at Kotak note. Also, with bond yields more-or-less firming up, treasury income gains in FY20 may be lower than in the past. Further, if profits do increase by way of lower taxes, analysts anticipate that much of it may be consumed to provide for possible loan losses. 

These factors also explain why analysts are reluctant to revise their earnings target just yet, despite lower tax rates being a positive move. “Near-term sentiments tend to be high on measures like this, but fundamentals haven’t changed so much for banks,” says Lalitabh Shrivastawa of Sharekhan. 

The deeper concerns for banking stocks remain a possible deterioration in asset quality and how their retail loan book will shape up, should there be a weakness in consumer sentiment driven by job losses in select pockets and salaries stagnating in the recent times. 

“Investors are worried about second order impacts from new stress emerging in the mid-corporate and SME space, as well as rub off effect on retail asset quality,” Ganapathy emphasises. Analysts say the September quarter results will hence be critical to take stock on their expectations from the sector. “For the first time in many years, I expect another round of earnings downgrade for banking stocks, particularly for private banks,” says a fund manager.

A lot would also depend on the government’s additional measures to revive economic growth, mainly the demand side. For now, experts believe investors should use the sharp rally to book profit across banking stocks.

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