Why Indian banks are the stocks to be in?

With the Sensex at 17200, most people have run out of options to put their money into. However one sector that looks extremely attractive at this point is banking. While most private banks are trading at mid-cycle multiples, almost all state owned banks are trading at book values, for core banking operations. If one includes the investment portfolios of state owned banks, the P/BV looks ridiculously cheap for an economy growing at 8.5-9%.
So just why are banks so cheap? RBI’s credit growth target for the current fiscal is 19%, which is what stocks are currently pricing in. Therefore any upside to the credit growth could re-rate the sector.

Why credit growth could beat the 19% estimate? If one looks at the lending by banks for the last few months, retail loans comprising of home and auto loans are showing stellar 25-30% growth while corporate loans are around 20%. With strong end user demand in the economy, it cant be long before businesses start re-investing heavily in adding capacities and corporate loans pick up further steam.

Last two years have seen credit growth of around 12% as most industries had postponed capex plans, due to a slowdown in demand. With demand coming back with a vengeance and sustaining, capacities will have to be added.

Key point to be noted is that credit growth has historically been 3x of GDP growth. Last two years GDP has grown at 6.5% and 8% while credit has grown at only 12%. Even for the current fiscal credit growth of 19% does not match with historical correlation as GDP is expected to grow at 8.5%.

Rising interest rates could also augur well for the sector as it will help expand net interst margin.

With monsoon season underway, the timing might just be perfect to enter the sector as a reasonably decent monsoon will also trigger credit growth in the farm sector and we may suddenly see markets going gung-ho over the sector.