Over the last one week the Indian banking sector has being one of the worst performing sectors, despite the rate cuts by RBI. This negates the orthodox view that the whenever the central bank cuts the rates the banking sector should perform and also came as a shocker to many investors/traders. However if we look at one of the most basic financial market indicators-10 year government bond yield , it would seem that this was inevitable and will continue further also.
What happened last week was despite the rate cuts by RBI bond yields were moving up, this is because of over-supply of bonds. The government is flooding the market with bonds (to finance its high deficits) but banks don’t have the appetite for such a large government borrowing and so in order to attract buyers government have to offer higher yields and thus lower bond prices (Since the bond prices and Yield always move in the opposite direction)
For most of the Indian banks (especially PSUs) a major portion of their assets are invested in Government Bonds (currently fixed at 25%). So any fall in the bond prices mean a MTM losses for the banking companies and thus a weak performance by the banking stocks.
I believe that due to worsening macroeconomic situation and widening deficits the government borrowing programme will continue putting upward pressure on yields despite the rate cuts and thus the Indian Banking Sector should remain weak in the coming weeks too.
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