After IMF's positive India forecast, public sector banks may see re-rating

Public Sector Banks (PSBs) are likely to witness a re-rating as the International Monetary Fund (IMF) projects a robust growth rate of 6.3 per cent for the current fiscal year and the subsequent year, according to a report by Motilal Oswal.

The IMF's growth forecast of 6.3 per cent is slightly lower than the 7 per cent prediction by the Reserve Bank of India (RBI). The IMF acknowledged the influence of India's digital public infrastructure and the government's strong infrastructure initiatives as key factors sustaining economic growth.

The report underscores the importance of macroeconomic stability in supporting India's economic resilience. The country's ability to maintain stability contributes to its growth outlook, according to the IMF.

PSBs have undergone a crucial transformation, leading to improved earnings quality. The combined profitability of six PSBs has surged to approximately Rs 91,200 crore in FY23 from a loss of Rs 29,500 crore in FY18, brokerage firm Motilal Oswal noted.

The IMF predicts that PSBs will sustain ongoing earnings traction, driven by factors such as enhanced loan growth, stable margins and controlled credit costs. This is expected to contribute to the continued re-rating of the sector.

Select PSBs are now guiding for a return on assets (RoA) of 1.2 per cent in FY25, indicating the potential for further earnings upgrades. Over the period from FY23 to FY26, the estimated earnings Compound Annual Growth Rate (CAGR) for PSBs is projected at 24 per cent, surpassing the expected 19 per cent for private banks, the brokerage firm added.

The report added that the evolving narrative on interest rates may further fuel the sector's earnings and growth outlook. The changing dynamics in this regard are expected to positively impact the profitability of PSBs.

PSBs have strengthened their capitalisation levels by accessing public markets, with most banks well-capitalised. New investment guidelines, allowing the inclusion of the Available-for-Sale (AFS) reserve in Common Equity Tier 1 (CET-1), are expected to benefit PSBs, with some banks gaining more than others.

The asset quality of PSBs has steadily improved after the challenges posed by the Covid-19 pandemic. Controlled Special Mentioned Accounts (SMA), healthy recoveries, and limited exposure to unsecured segments contribute to positive asset quality trends, Motilal Oswal said in a note.

PSBs are well-capitalised, with a CET-1 ratio ranging from 10 per cent to 13 per cent for the top seven PSBs. The robust internal accruals and recent increases in risk weights on unsecured loans position PSBs favourably for sustained loan growth.

PSBs have witnessed a turnaround in earnings since FY21, achieving a 1 per cent RoA for five out of six PSBs. The sector is expected to sustainably deliver a RoA of 1 per cent or more over FY24-26, reflecting potential for further re-rating.