PNB scam and NPA crisis: Are we looking at a long-term bear market?

The Rs 14 billion scam at Punjab National Bank (PNB) has dominated headlines and shaped sentiment through the last week. Nobody is clear as to what the final damage across the banking system would be, since we don’t yet know which banks are exposed to the Letter of Undertakings (LoUs). There is some political fallout and there could be more, given the absconding jewellers’ connections with the high-and-mighty.

It’s no secret that Indian banking is in dreadful shape. The Q3 results indicate that losses, as well as Non Performing Assets (NPAs), are still rising. PNB was one of five PSU banks that officially declared profits, totalling about Rs 8.5 billion for this set of five. PNB’s declared profits of Rs 2.3 billion are dwarfed by the scam’s likely losses. The other 16 PSU banks declared losses totalling over Rs 189 billion, including SBI’s losses of Rs 24 billion and Bank of India’s losses of Rs 23.4 billion.

The RBI estimated in its last Financial Stability Report that NPAs could hit 11 per cent of all advances by September 2018. That number will climb. Chances are, the proposed bailout of Rs 2.2 trillion will not be enough to recapitalise PSU banks. Eventually twice that sum, or even more, might be required.

In other news, the RBI held policy rates stable in its bi-monthly review. One member of the Monetary Policy Committee wanted a rate hike; the other five members voted for status quo. The central bank expects inflation to move higher, while it sees growth gradually improving by about 0.75 per cent of GDP in the 2018-19 fiscal.

The Consumer Price Index (CPI) data for January 2018 indicates that retail inflation may hold at acceptable levels. The January 2018 CPI was up 5.07 per cent year-on-year , which is an improvement on 5.21 per cent YoY in December 2017. Food inflation softened, but higher crude prices almost balanced that out. Bond yields have already moved up in anticipation of a future where inflation run high, while poor balance sheets impede banks’ ability to lend.

The Index of Industrial Production  (IIP) rebounded to 7.11 YoY in December 2017. This is off a low base but it is a good signal. The IIP was driven by 8.4 per cent growth in manufacturing, while Electricity and Mining, were up 4.4 per cent and 1.2 per cent respectively. Apart from base effects, the IIP is notoriously volatile.

Another crucial high-speed indicator — vehicle sales — showed excellent results for January. Growth in production and despatches to dealers was up 30.7 per cent YoY, which is impressive despite a base effect. Commercial vehicles, two-wheelers, three-wheelers and utility vehicles (within the passenger segment) showed the best growth rates.

The Purchasing Managers’ Index (PMI) for January showed mildly contradictory signals. The manufacturing PMI was strongly in expansion mode at 52.4 (below 50 is contraction, 50 is neutral) but it was lower than the 54.7 recorded in December. The services PMI was at 51.7 indicating a little acceleration over the mild expansion of 50.9 recorded in December. The Business Confidence Index is yet another sentiment measure, released every quarter by the National Council of Applied Economic Research (NCAER). That also registered a growth of 9.1 per cent in January, after declining for two consecutive quarters.

The Q3, 2017-18 results do suggest that there is a pick up but it is gradual. A look at the first 2,000-odd companies to release Q3 results (excluding banking and oil & gas) indicates that net profits have grown at around 10 per cent which is the best in five quarters. FMCG and cement companies produced good results for instanbce, which suggests that consumption is improving. Crude and industrial metals have seen a global price-surge. Operating margins seem to have improved a little.

In terms of investor segments, retail investors have been selling since the Budget and Foreign Portfolio Investors started selling last week. Thus far, Domestic Institutions have picked up the slack, buying enough to keep the major indices from falling off a cliff. However, there has been carnage in smaller stocks and the Financial sector has been hit much harder than the major market indices.

While the Nifty has fallen 5.12 per cent since the Budget, the Nifty Bank  has fallen 7.56 per cent. A large component of the domestic institutional buying is driven by mutual funds, which have to invest the funds subscribed to them by retail investors. The change in sentiment could infect this segment if retail investors start cutting back on their fund commitments.

FPIs are unhappy about the fiscal slippage and protectionist elements in the Budget and they don’t like the implications of the PNB scam either. The kneejerk decision last week to cut off Dubai and Singapore’s access to data from Indian exchanges also hasn’t gone down well. So far however, the rupee hasn’t suffered too much. It’s down 4 per cent versus Yen and down 1.5 per cent versus Euro. But it’s down only 0.46 per cent against USD and 0.2 per cent against GBP.

If the selling continues, the 200-Day Moving Average of the major indices could be tested. That’s about 3.5 per cent lower than the current trading levels for the Nifty at around 10,075. If the 200 DMA does break, the technical assessment would be a long-term bear market.

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