Demonetisation hits financial sector’s weight in Nifty

Banks and financial services companies lose out to information technology and power firms

Demonetisation has taken the zing out of India’s booming banks and financial services sector. There has been a 100-basis point (bp) decline in the sector weight in the benchmark NSE Nifty 50 Index in the last quarter due to investors’ concerns on the adverse impact of demonetisation on the financial sector’s earnings.

The sector’s weight in the index stands reduced to 29.2 per cent, down from 30.2 per cent at the close of September 2016 quarter. Bank stocks have been hit after the note ban. The Bank Nifty Index, which comprises 12 banks, is down 7.5 per cent since November 8 last year when demonetisation was announced, against a 4.1 per cent decline in benchmark Nifty 50 Index during the period.

The Nifty Financial Services Index, that includes non-banking finance companies, suffered even more and has lost 8.6 per cent of its value during the period, and is the second biggest sector loser after the beleaguered real estate sector. Nifty Realty Index is down 12.5 per cent.

In comparison, the financial sector was one of the top performers during the July-September quarter, resulting in a sharp rise in its index weight. The sector weight was up 220 bps during the second quarter. One basis point is one-hundredth of a per cent.

The slack has been picked up by sectors such as information technology (IT) services, power and utilities companies. For example, the Nifty IT Index is up 3.54 per cent since demonetisation, while the BSE Utilities Index is up 3.3 per cent during the period.

There are eight financial stocks in the Nifty 50 benchmark index, which include seven commercial banks and Housing Development and Finance Corporation (HDFC), the country’s largest non-bank lender.

The index weight has been calculated by BS Research Bureau and is based on the quarter-end market capitalisation and shareholding pattern of respective index companies. The index weight is calculated by excluding the value of promoter holding in companies.

Experts see more pain for the banking sector going forward due to a combination of lower credit growth, high valuations and decline in lending rates after demonetisation.

“A cut in lending rates by banks would compress the net interest margin for banks, hitting their earnings in near to mid-term. On the business side, credit demand growth continues to shrink, making it tough for banks to grow their interest income. Year-on-year growth in industrial credit growth declined to multi-year low of six per cent during the fortnight ended December 9 last year,” says G Chokkalingam, founder and chief executive officer, Equinomics Research & Advisory.

He also sees pain for banks due to their high valuation despite a slowdown in industry’s growth metrics.

“Most of the high-performing private sector banks such as HDFC Bank, IndusInd Bank are trading three to four times their book value, which is just not sustainable in the current environment,” adds Chokkalingam.

Dhananjay Sinha of Emkay Global also sees banks taking a hit from demonetisation. “Banks’ core business of lending and fee-based activities has been completely disrupted by demonetisation. Total potential loss from this would run into thousands of crores of rupees. Besides banks are now saddled with large deposits, with few avenues to lend except investing in government bonds leading to a sharp decline in their margins.”

Others, however, see an opportunity in the correction. “Valuations have become reasonable for many private sector banks and we are constructive on the sector now. Demonetisation would lead to banks’ booking gains in their bond portfolio, while a surge in deposits would lower their cost of funds for few quarters at least,” says Swati Kulkarni, executive vice-president and fund manager, UTI Mutual Fund.