Petrol Hike Fuels Bank Rally Investors go long on bank stocks on hope that RBI may cut interest rate on further fuel price hikes

 Traders covered their bearish bets on banks on Thursday and initiated long positions amid hopes the RBI may cut policy rates if the government raises diesel and cooking gas prices on the heels of increasing petrol prices. Bank of Baroda led the rally in banking stocks with a 5.2% gain. Axis Bank rose 3.6%, ICICI Bank advanced 3.5% and SBI edged up 0.6% on Thursday. BSE's Bankex, which rose 2.3%, was the biggest gainer among indices. 

The RBI had said it would ease monetary policy further — after cutting a policy rate a month ago — only if the government tightens its finances. Fuel subsidy burden has been the biggest drain on the government's finances. 

"If diesel and LPG prices are raised as hoped, banking stocks could extend Thursday's gains, which were built mainly on expectations of such hikes," said Rajat Rajgarhia, director-research, Motilal Oswal Securities. "This, along with a correction in crude oil prices over the past two weeks and robust Q4 numbers, could act as strong support for the likes of ICICI Bank and SBI." 

The jump in banks and ONGC shares contributed to the rally in benchmark indices on Thursday. BSE Sensex gained 274.20 points, or 1.7%, to close at 16222, its biggest gain in almost two months. Nifty gained 85.75 points, or 1.77 %, to end the day at 4921. 

Traders' optimism regarding bank stocks was borne out of an increase in the open interest on the stocks' derivatives contracts, the prices of which also rose. Outstanding positions, or open interest, jumped on Thursday by 9.8 lakh lots to 71.94 lakh in ICICI Bank futures. Axis Bank futures saw a build up of 9.6 lakh lots to 1.1 crore, SBI futures rose 3.35 lakh lots to 55.03 lakh and Bank of Baroda futures saw a rise in open interest by 1.91 lakh lots to 30.23 lakh. 

According to Siddarth Bhamre, head of derivatives, Angel Broking, reining in the subsidy bill will help banks because foreign investors would view this development positively and possibly revive their investment in equities, especially in large-cap stocks. "If this happens, banking stocks, which account for a fifth of Nifty's weightage, would be sure-shot candidates for investors looking for value picks," he said. 

Bhamre said SBI, Axis Bank and ICICI Bank are top picks if the government went ahead and reduced fuel subsidies further. However, deteriorating asset quality will keep a lid on probable gains in bank shares. "While GNPAs (gross nonperforming assets) have peaked, we expect higher restructuring in 1HFY13 to keep valuations in check," said Motilal Oswal Securities in a note to clients. 

Analysts said private banks are better placed than their public sector peers in asset quality. 

"Asset quality remained dichotomous; private banks improved further while PSU banks weakened more, measured across parameters like credit costs, NPL and coverage ratios and restructured assets (PSU banks restructured 2.5% of loans in 4Q12)," said Citi in a note to its clients. "We expect more deterioration – but a moderation in the pace of new slippages though will be vulnerable to further macro deterioration," it said.