Bear market approaching! Tightening by central bank and pressure from Middle East conflict may further exacerbate the $95 billion drop in Indian bank stocks.

The banking sector, which has the largest weighting in the Indian stock market, may face more downward pressure. The Reserve Bank of India's intervention in the forex market, as well as the impact of rising energy prices on the economy, are weakening the profit prospects of banking stocks. The RBI's interventions to defend the record-low rupee exchange rate have limited its ability to inject liquidity into the market, leading to tightening financial conditions, which could pose pressure on banks in the coming quarters. Meanwhile, the ongoing escalation of the Middle East conflict may disrupt India's nascent credit recovery process, threatening loan growth as the overall economy cools down. Data from the National Securities Depository Limited (NSDL) shows that global investors withdrew a record INR 327 billion (approximately USD 3.5 billion) from Indian financial services stocks in the first two weeks of March. Since early March, the Nifty Bank Index's market value has evaporated USD 95 billion, coming close to entering a bear market - a 20% decline from recent highs. Kranthi Bathini, stock strategist at WealthMills Securities, said, "Due to the possibility of a tight monetary policy, these stocks may face further pressure in the short to medium term." However, he added that after this round of adjustment, valuations are becoming attractive. Given that banking stocks account for nearly one-third of the Indian benchmark index, their prospects directly affect the direction of this USD 4.5 trillion stock market. If banking stocks continue to weaken, it could drag down the overall market. Currently, the Indian stock market is one of the worst-performing markets in the Asia-Pacific region, with a cumulative decline of 13% year-to-date. Bulls point out that banking stock valuation multiples are improving, and India's long-term economic growth remains among the best in the world. The current price-to-book ratio of the Nifty Bank Index (calculated based on one-year forward earnings) is 1.5 times, the lowest level since 2020, suggesting an attractive risk-reward ratio. Citibank has started to prioritize private banks over state-owned banks, believing that the former can better absorb macro pressures - which has become the most concerning risk factor for investors. However, Jefferies expects that banks may face losses of up to INR 50 billion due to forced closure of forex positions by the RBI. Fitch Ratings believes that with tightening financial conditions, net interest margins for banks may narrow by 20-30 basis points by the end of the fiscal year 2027, or below the 3.1% level previously forecasted by the rating agency. Rajat Agarwal, Asia strategist at French Industrial Bank (Societe Generale SA), said, "The bank's investment portfolio will certainly be impacted to some extent. We have recently seen a rebound in credit growth, but the key is how much of this rebound will be reversed by the war."