In a significant move for the banking industry, the central government has proposed to lift the embargo on grant of government business to private banks. Whereas, de facto the government has always favored public sector banks for grant of government business, the de jure embargo was imposed in 2012 post global financial crisis to protect the small savers and public entities from a potential collapse. Initially the embargo was imposed for a period of 3years; but it was extended further in 2015; through some private sector banks with public sector legacy (ICICI, Axis etc) were continued to be permitted to conduct some part of the government agency business. As per the latest announcement, the embargo is proposed to be lifted completely.
This announcement has come at a time when the government would
be starting the process privatize couple of public sector banks (PSBs), and
diluting its shareholding in other PSBs. In past couple of decades, many public
sector undertakings have faced serious consequences due to dilution of
government patronage to their business and/or introduction of private sector
competition in their field of operations, e.g., Air India, BHEL, BEML, STC,
MMTC etc. Obviously, lifting of this embargo will seriously impact the
profitability of many smaller PSBs. Even larger PSBs will be impacted to some
extent. The already subdued valuations of PSBs will naturally get further
discounted. Banks like Jammu and Kashmir Bank, which substantially rely on
government business, could face serious issues of sustainability.
The moot point therefore is whether liberalization in grant of
government and public sector business must inevitably result in destruction of
public sector wealth, or the liberalization could be better managed.
On a different note, RBI appears to be quite concerned about the
financial markets and economic growth. RBI governor has been categorical in
cautioning about crypto currencies. He has also raised the issue of divergence
between performances of economic performance and stock market repeatedly. He
has also raised concern over second round effect of fuel prices on economic
growth.
Whereas, the financial markets and bond markets are fast pricing
in an economy “overheating” scenario with sustainable rise in inflation, RBI
has reiterated its commitment to continue with “accommodative” policy stance.
In recent past, multiple bond auctions by RBI have devolved due to lack of
demand at RBI cut off yields.
Obviously there is a divergence in RBI and market’s outlook
about the price and yield scenarios. This implies either of the following two
scenarios:
(i) RBI is running
behind the curve. If this is the case, the market shall be ready for a rate
shock, whenever RBI does the catch up Act. Last time I remember this happened
was during Subba Rao tenure, when multiple hikes were implemented in short span
of time.
(ii) RBI assessment
of economic and earnings growth is closer to reality. In this case, also
markets may be surprised negatively as it is pricing in a sharp recovery in
earnings over FY22-23.
Historically, the disagreements\ between market consensus and
RBI have not ended well for markets. I hope, this time it is different.
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