The last time the Reserve Bank of India (RBI) cut interest rates, the markets fell sharply. This is because so much of anticipation was built around the fact that interest rates would be cut that investors had taken positions well in advance. It was a classic case of "sell on news".
With inflation (some are now calling the situation as deflationary), especially WPI inflation coming in at historic lows, one is almost certain that the RBI would cut interest rates.
So, most investors may have already bought banking stocks ahead of the RBI policy. Though, this time there is a slight worry that banking stocks have not risen sharply ahead of the RBI policy. ICICI Banking is languishing at Rs 268, SBI near the Rs 240 levels and most banks on Thursday saw a drop in their share prices.
This means should the RBI drop interest rates, you might not see a sharp drop in banking shares as in the past. Having said that much would depend on the commentary by the RBI. Many analysts expect the central bank to be cautious on inflation and hence a hawkish tone would mean bad news for banking stocks. With RBI Governor Raghuram Rajan firmly deciding to fight inflation, he may not signal sharp cuts in interest rates in the future in the RBI commentary.
Hence, we do not see banking stocks making substantial gains in the future. Therefore, it may not be prudent to take large positions in banking stocks in view of worries over the RBI commentary.