Are banks hiding something?

While third quarter results do not reflect it, the sector's reluctance to cut interest rates points towards either high NPAs or wrong strategies.

The fuel price cuts would have been welcome to almost every industry outside of the oil and gas sector. These should help ensure that the Reserve Bank of India's (RBI) inflation expectation of around 3 per cent WPI by March-end is met.

On the basis of the price-cut, the viability of the entire transport sector improves. There has already been some speculative action in auto-manufacturing stocks, which actually looks incongruous on the basis of Q3 results. Auto-industry Q3 profit and loss accounts have ranged from flat in the case of two-wheeler players to massive losses for Tata Motors. The optimists are hoping that sales will pick up now that "mileage" costs are easing.

Lower diesel prices ensure that both the road and rail-transport sectors and the logistics business as well have better margins. It makes a positive difference to every manufacturing business that transports by road and it gives the railways room to slice freight rates. It may also make a positive difference to coastal shipping, which buys its fuel at Indian prices.

In free markets, there is a close correlation between petro and gas and coal prices. This is not so in India but Indian petro-product price-cuts reflect lower crude costs. Along with falling international crude prices, gas and coal prices have also fallen. Since India imports significant amounts of both, domestic prices (which are controlled) are also likely to reflect the international prices which they are benchmarked against.

That means a boost for the conventional energy sector. In turn, that could mean easier closure for independent power projects that have tied up fuel sources. Of course, this is not great news for renewables. It implies less interest in an already beleaguered sector. For a brief while, wind energy was competitive with fossil fuels, in terms of levelised costs. There was also a great deal of enhanced interest in alcohol and bio-diesel. These sectors will probably need differential tax breaks all over again.

Of course, the refining sector itself would be unhappy. The cuts leave the PSUs with less room to recoup some of the massive losses they suffered over three years of price-subsidy. It also further reduces margins for the private refiners as well but they are more focussed on exports, which have already been hit by lower margins.

But overall, the price cut is certainly good for the economy as a whole. However, it is a moot point if it will result in an immediate revival of demand for either internal combustion vehicles or for the transport of goods. Sentiment is so poor at the moment, demand revival will come only with a significant lag.

The other problem is the continued refusal on the part of banks to pass on policy rate cuts RBI has already made. RBI has in fact, decided to maintain its current monetary profile despite its own predictions of lower growth and lower inflation. The reason is probably that it's waiting for market rates to come down further.

Without cheaper money, there is unlikely to be a revival in demand. This is definitely true for retail consumer-driven businesses like home loans and auto sales. It is almost certainly true for large-scale infrastructure projects as well. Big projects have found it difficult to organise financial closure at viable rates. Some promoters have simply put up the shutters and decided to wait for rates to drop.

We are witnessing a strange dichotomy. Inflation has come down rapidly from its September peaks. By some estimates, the past 4 months have seen (annualised) a minus 13-14 per cent rate of inflation at wholesale level. Equity valuations in terms of earnings ratios have eased to levels that have not been seen since the last bear market in 2002-03. Stock prices are down to 2006 -levels.

The most expensive thing is money itself. This seems irrational because logic suggests that cutting rates sharply would be a win-win decision for banks. The only rational possibility is that banks are sitting on massively increased non-performing assets (NPAs). However, the Q3 results don't reflect that. Nor is there a shortage of liquidity if credit-deposit ratios are to be believed.

Therefore, banks may be collectively concealing big holes and these will perhaps, come to light in Q4. Or, every bank has got its strategy wrong. Both conclusions seem to be dire.