India Financial Sector to Benefit from Economic Growth

India Financial SectorIndia is all set to become a $5Trillion Dollar Economy in GDP terms by 2025. Backtracking the numbers, Financial services will be a big beneficiary – of this growth. According to Morgan Stanley, for this GDP growth to be achieved, the financial services sector will need to grow in the high teens over the decade.

The last three years have not been kind to the India Financials. The persistent economic slowdown and high interest rates caused default levels to rise meaningfully – impaired loans in Indian banks are now at almost 12% compared to less than 5% three years ago. This has caused profitability and capital levels of a large part of the system (SOE banks are 75% of the system) to come off sharply. The risk is that banking sector problems cause the next slowdown in the economy as more banks are unable to dispense credit.

To turn this vicious cycle into a virtuous one, there needs to be substantial loan growth to multiple parts of the economy. That requires a recapitalization of SOE banks of around US$50bn and private lenders of around US$15bn. However, to fix the banking system and therefore to give economic growth the greatest chance of success, the new government will need to use that mandate to act decisively in the next months and years. These are not going to be easy steps, but with the right policy choices from the government and prudent financial management from the banks, earnings growth averaging in the high teens is possible.

India’s currently underpenetrated financial services sector could deliver significant, outsized returns especially the Best Portfolio Private Sector Banks Such as HDFC Bank, ICICI Bank, Kotak Bank, HDFC and Axis Bank. These can survive any Global Shocks like that of 2008 Lehman Crash as well and will deliver 18-24% CAGR in returns over the next five years. Stay Invested in these if you already hold or BUY and HOLD on correction. In the worst case we expect them to deliver atleast returns higher than that of SENSEX.