SBI Downgrade and RBI Interest Rate Policy-VRK100-08Oct2011

SBI Downgrade and RBI Interest Rate Policy

Rama Krishna Vadlamudi, HYDERABAD 08 October 2011 www.ramakrishnavadlamudi.blogspot.com

The Moodys downgrade of State Bank of India has huge consequences for banking sector in India. The downgrade has brought to focus the issues that are bedeviling the sector. Let us hope that the Government will take some action to address the issues head on and without any further delay. Reserve Bank of India is known to be a good caretaker of banks. Now that SBI is downgraded, can we expect RBI to change its hawkish stance on interest rates with a view to bringing relief to banks? Moody's Investors Service has downgraded the State Bank of India's (SBI) bank financial strength rating (BFSR), to D+ from C-. This has resulted in the downgrade of the Hybrid debt rating to Ba3 (hyb) from Ba2 (hyb). The rating agency cited the delay in capital infusion by the Government and deteriorating asset quality as reasons for the debt downgrade. SBIs Tier I capital has come down to 7.6 per cent as on 30 June 2011. SBIs NPAs are at Rs 27,768 Crore or 3.52 per cent of loans as on 30 June 2011. SBI five-year credit default swap went up by 90 per cent since August 2011 from 189 basis points to 363 basis points now as per Bloomberg. The current CDS premium of 363 basis points (or 3.63 per cent) indicates that for every 100-dollar worth of investment in SBI paper, investors have to pay premium of 3.63 dollars to protect themselves from default. Many banks witnessed

jump in their CDS premiums of late due to concerns of sovereign debt crisis. If you want to know more about CDS, just click:
http://ramakrishnavadlamudi.blogspot.com/2011/10/credit-default-swaps-their-basics.html

The Government of India has been dithering on capital infusion for almost a year unable to decide on its subscription as a 60per cent shareholder to SBIs proposed rights issue. The slow decision-making has cost the bank a great deal of reputation. What the downgrade clearly points to is that the cost of raising money will increase for SBI on the international markets. The Central Government is facing many problems on the fiscal front and its Rs 40,000-crore disinvestment programme is in a limbo. Against this background, one needs to be circumspect about the ability of the Government to part with funds. There is no doubt that the Moodys downgrade has come as a bolt from the blue for SBI as well as for the Government. Ironically, the bad news has emerged when a string of banks in the eurozone and the US have been downgraded. One cannot compare Indian banks with the much bruised and battered European or US banks who are in deep trouble. As a Banker to Every Indian, SBI has its own strengths. However, the Moodys downgrade of SBI has dented the confidence and trust investors, if not other stakeholders, have reposed in SBI for long. We know actions have consequences. Sometimes, the consequences are unintended. Evidence suggests that whenever banks face some difficulties, Reserve Bank of India comes to their rescue in one form or another. Now that SBI is downgraded and is feeling the pressure of deteriorating asset quality, is it unreasonable to think that RBI will shed its dear money policy and

indicate that it is going to start cutting interest rates sooner than later? Overall, investors will be better off not touching the SBI equity shares for the time being, even at the current market price of Rs 1,750 per share, unless one can see firm commitment from the Government to pump money into SBI. Sentiment wise also, it is difficult to buy a stock when the erstwhile blue chip has come down by 50 per cent from its yearly peak of Rs 3,500. To put it differently, the stock has lost Rs 1.10 lakh crore of its market capitalization in the past eleven months. This 50-per cent fall is way above the fall of 32 per cent in Bank Nifty index and 36 per cent fall of archrival ICICI Banks scrip. It would not be a surprise if ICICI Bank would surpass SBIs market capitalization in the next one year as the gap between the two behemoths is narrowed down to just 14 per cent.