Lookback: How PSU banks outpaced private peers in the 18-month cycle to August 2024

The 145% versus 18% gap between Nifty PSU Bank and Nifty Private Bank wasn't a momentum trade. It was a rerating cycle the street under-owned for a year, then over-owned for one quarter.

By the time the 6 August 2024 session closed, the PSU bank trade had already done its loudest work. The Nifty PSU Bank index, measured from the 13 February 2023 base that the brief anchors this cycle to, had compounded a return of roughly 145% over eighteen months. The Nifty Private Bank index, over that same window, had moved 18%. On any conventional reading of Indian financial sector behaviour, where private lenders had carried the index for the better part of a decade, that gap was not just unusual. It was the dominant story of FY24 and the first quarter of FY25, and it deserves a clean retrospective now that the dust has settled.

The brief lands me on a specific question. Was this a fundamentals-led rerating that the market belatedly priced, or was it a flow-and-narrative cycle that ran far ahead of book value and was always going to give some back? The honest answer is that it was both, in that order, and the inflection between the two phases sat almost exactly at the Union Budget of July 2024.

Caption: The weekly view shows the full cycle. The PSU line breaks away from the private line in mid-2023 and the gap widens almost without pause until the July 2024 Budget week.

What triggered the move

Going into early 2023, the setup was unloved in the most useful way. PSU bank balance sheets, after the asset quality review pain of 2015 to 2018 and the COVID provisioning of 2020 and 2021, had been steadily cleansed. Gross NPA ratios at the larger public sector lenders, which had peaked in double digits, had compressed to mid-single digits over five years. The recapitalisation programmes of the prior decade, combined with internal accruals and improving credit costs, meant that the capital adequacy gap versus private peers had narrowed materially. None of this was news on 13 February 2023. It had been visible in quarterly filings for six quarters. The market simply hadn't paid for it.

That stance broke for three reasons that compounded through the year.

The first was the credit growth divergence. Bank credit growth across the system ran in the mid-teens through 2023, and PSU banks, having de-risked their corporate books, captured a disproportionate share of large-ticket lending into capex-linked sectors. Roads, renewable power, defence, railways and city gas distribution, the verticals that the central government was explicitly funding through its expanded capital outlay, ran on PSU balance sheets. Private lenders, with their higher unsecured-retail mix and tighter risk filters, were structurally less exposed to that pipeline. When the capex narrative caught on in the second half of 2023, PSU banks were the cleanest vehicle through which to express it.

The second was the deposit cost gap. By the third quarter of FY24, private banks were openly flagging deposit mobilisation as their binding constraint. The system loan-to-deposit ratio had pushed past 80%, and HDFC Bank's post-merger deposit profile, in particular, was being scrutinised in every brokerage note. PSU banks, with their branch network and sticky CASA from government and pensioner relationships, simply did not have the same problem. Margin compression hit private lenders harder and faster.

The third was earnings beats. Through the four quarters from March 2023 results to March 2024 results, the public sector pack consistently delivered net profit numbers above consensus. Provisioning reversals, recovery from written-off accounts, and treasury gains on a falling bond yield path in late 2023 all flattered the bottom line. The aggregate net profit for the listed PSU bank pack, by FY24 closing prints, was running at a record. Earnings upgrades begat target price upgrades. Target price upgrades begat ownership, first from domestic institutions and then, more slowly, from foreign ones.

What sustained the move

A trigger is one thing. What kept this trade running for eighteen straight months was the flow architecture underneath it.

Domestic institutional flow, the DII bucket that NSDL reports broadly capture, was the load-bearing pillar. SIP gross inflows, which had crossed the ₹20,000 crore monthly mark during this window, were being deployed by active mutual funds that were structurally underweight PSU banks at the start of the cycle. As the rerating ran, fund managers were forced to close the underweight or accept tracking-error pain. That mechanical buying provided a floor under every dip. State Bank of India, Bank of Baroda, Canara Bank, Punjab National Bank and Union Bank, the obvious top of the cycle leaderboard, all saw their domestic mutual fund holding rise quarter on quarter through FY24.

FII flow was the more complicated piece. Foreign investors were sceptical for most of 2023, and the early move was, in flow terms, almost entirely a domestic phenomenon. That changed through the first half of 2024, when the combination of an emerging-market rotation out of China, India's index weight gains, and the visible earnings track record finally pulled foreign money in. By the run-up to the general election results in June 2024, foreign positioning in PSU names had risen meaningfully from a low base. That was a late-cycle development, not an early-cycle one, and it matters for the next section.

Brokerage flow was the third force. Through 2023, the sell-side was cautious. Most large houses carried Add or Neutral ratings on the larger PSU lenders with target prices that were repeatedly chased and breached. By the first quarter of 2024, those target prices had been upgraded twice or thrice across the pack, and the language had shifted from valuation discipline to franchise quality. When the sell-side, in aggregate, moves from sceptic to believer near the top of a cycle, the marginal new buyer base has narrowed. That was the position by May and June of 2024.

Caption: The daily chart compresses the action of the final 120 sessions. The vertical move into early June, the post-election volatility, the Budget-week reversal, and the early-August consolidation are all visible.

Leadership rotation within the sector

The PSU bank pack did not move as a uniform block. The cycle had three distinct leadership phases.

Phase one, from February 2023 through roughly October 2023, was led by the largest and cleanest names. State Bank of India, the bellwether, did the early heavy lifting. Bank of Baroda was the second leg. These were the lenders where the institutional underweight was most acute and where the rerating from a price-to-book of well under one to something approaching one was the most defensible.

Phase two, broadly from November 2023 to March 2024, was the catch-up trade. The mid-sized PSU lenders, Canara Bank, Punjab National Bank, Union Bank and Indian Bank, ran harder than the leaders on a percentage basis. The logic was straightforward arithmetic. The starting valuation was lower, the earnings revision cycle was more recent, and the same flow that was now committed to the sector was rotating into names with higher beta and smaller free float.

Phase three, from April 2024 into early July 2024, was the speculative leg. The smaller PSU lenders, the ones with thinner trading volumes and limited institutional coverage, became the late-cycle outperformers. Indian Overseas Bank, UCO Bank, Central Bank of India and Punjab and Sind Bank, names that institutional desks had been ignoring for years, ran on retail flow and momentum factors. The free float in some of these names was so constrained that any incremental demand moved price violently. When the sell-side started flagging Department of Investment and Public Asset Management led stake sales as supply overhangs, the music for that leg slowed.

On the private side, the leadership rotation was almost the inverse. Through this cycle, the index aggregate of 18% hides a wide internal dispersion. ICICI Bank, the most consistent performer in the private pack on operating delivery, carried most of what little gains the index showed. HDFC Bank, weighed down by the merger transition and its deposit cost overhang, was a meaningful drag for most of the window and only began to find a floor in the second quarter of 2024. Axis Bank delivered respectable earnings without commensurate stock action. Kotak Mahindra Bank dealt with regulatory restrictions on its digital onboarding through 2024, which materially capped its rerating. IndusInd Bank, which had its own asset quality questions, oscillated without trend.

The mid-cap private space, the federal bank, RBL Bank, IDFC First Bank cluster, was a story of micro-events. None of them caught a sectoral tailwind in any sustained way. The cycle, in private bank terms, was a stock-picker's market with very little index-level help.

What reversed it

The reversal, when it came, was not a fundamental break. It was a positioning unwind triggered by policy and election arithmetic.

The general election result on 4 June 2024 was the first tremor. The narrower-than-expected mandate for the incumbent coalition introduced uncertainty about the pace of capital expenditure, the privatisation pipeline and the disinvestment programme. PSU banks, which had been priced for a clean continuation of the prior policy track, gave back ground in the immediate aftermath and recovered through late June as the new cabinet's intent on capex was clarified.

The Union Budget of 23 July 2024 was the bigger blow. The capital gains tax structure was tightened, with short-term and long-term rates and the STT on derivatives all moved up. The market read that as a clear signal that retail froth, which had been most visible in the smaller PSU names, would be moderated. The Budget also clarified disinvestment intent in a way that suggested supply, eventually, would come back into the PSU pack. The two days following the Budget saw the sharpest single drawdown in the Nifty PSU Bank index in the entire eighteen-month cycle. Private banks, by contrast, were relatively insulated, and the divergence between the two indices began to narrow from the day of the Budget itself.

Through the last week of July and the first week of August 2024, the PSU pack stabilised but did not recover the highs. Quarterly results from the larger lenders, which printed through the first half of August, were broadly fine on book quality but flagged margin pressure for the first time in the cycle. The narrative had shifted from upgrade momentum to consolidation. The 6 August 2024 close, the anchor date for this lookback, captured the sector in that consolidation phase. The Nifty PSU Bank index was off its mid-June peak but still up materially for the calendar year. The cycle, on any reasonable read, had completed its dominant leg.

Caption: The 30-minute view shows the texture of the consolidation phase. Tight ranges, choppy moves around results, and visible profit-taking into every intraday strength.

Cross-sector comparison

The PSU bank cycle did not run in isolation. The same eighteen-month window saw a broader public sector enterprise rerating that lifted defence stocks, railways related counters, power financiers, shipbuilders and the PSU utility space. Nifty PSE and Nifty CPSE both compounded at rates that, while not matching the PSU bank index, were comfortably ahead of the broader Nifty 50. The common thread across these pockets was the same combination of cleansed balance sheets, capex-linked order books and an institutional starting underweight.

The clearest laggard, against the PSU complex, was the consumer staples basket. Nifty FMCG underperformed the Nifty 50 materially through this window, weighed by rural demand softness, raw material cost cycles and the absence of an earnings upgrade narrative. The IT services pack also lagged for most of the cycle, with the obvious dollar-revenue softness through 2023 and only a tentative recovery in early 2024.

Within financials, the divergence between PSU banks and private banks was mirrored, though less dramatically, in the non-bank lender space. PSU NBFCs, the REC and PFC pair in particular, ran hard on the same capex thesis. Private NBFCs, especially those exposed to unsecured retail credit, faced the November 2023 RBI risk-weight tightening that capped their multiples through the rest of the cycle. The pattern, public outperforming private inside financials, was a sector-wide phenomenon, not a bank-specific one.

Historical analog

The closest historical analog for this cycle was the 2003 to 2007 phase, when PSU banks ran from depressed valuations on the back of a capex revival, falling NPA cycles and rising credit growth. That move ended, eventually, with the global financial crisis exposing the asset quality risks that had been building underneath. The 2023 to 2024 cycle differs from that template in two important ways. The starting balance sheet was, on most metrics, considerably cleaner. And the credit growth that fuelled the move was less concentrated in leveraged corporate paper and more spread across government-funded infrastructure plus retail.

The cycle also rhymed, in a smaller way, with the 2014 to 2015 PSU rerating that followed the change of government, which proved short-lived because the underlying asset quality picture had not actually improved at that point. The 2023 to 2024 move had more fundamental support than the 2014 attempt, which is why it ran longer and harder.

The most useful read from these analogs is that PSU bank cycles, when they happen, tend to be sharp and front-loaded. The dominant returns arrive in the first twelve to fifteen months. Late-cycle leadership rotates into lower-quality names within the pack, which is a signal worth respecting. By the time the smallest PSU lenders are leading the index higher, the trade is usually closer to its end than its beginning. The cycle ending in August 2024 followed that pattern with unusual fidelity.

Where the cycle stood on 6 August 2024

At the close of 6 August 2024, the cycle was not broken. It was paused. The Nifty PSU Bank index had given back a chunk of its mid-June froth but remained well above its February 2023 base. The Nifty Private Bank index, after eighteen months of underperformance, was finally showing signs of relative strength, helped partly by ICICI Bank's continued delivery and partly by the easing of the deposit cost cycle that the RBI's stance was hinting at.

The next leg, whether it would be a renewed PSU push or a private bank catch-up, depended on three things that were visible at the time. Whether the new government's capex intent translated into actual order flow by the December 2024 quarter. Whether the disinvestment pipeline brought supply back into the larger PSU lenders. And whether private banks could rebuild their deposit franchise without further margin damage.

On the balance of available evidence at that 6 August close, the asymmetric trade had already been made. The easy money in the PSU bank rerating had been earned by the early-cycle owners and was being distributed, through late-cycle volatility, to the latecomers. The private bank pack offered cleaner risk-reward on a forward twelve-month horizon, though without the index-level conviction that the PSU trade had carried.

Verdict

Stance: NEUTRAL on Nifty PSU Bank, mildly BULLISH on Nifty Private Bank, on a relative basis from the 6 August 2024 close. Horizon: 3 months. Rationale: The PSU rerating had captured most of its fundamental tailwind by mid-2024, with late-cycle leadership rotating to lower-quality names, sell-side fully on board, and policy plus supply overhangs visible. Private banks, after eighteen months of underperformance, offered the cleaner relative setup as the deposit cycle eased and the valuation gap to PSU peers had narrowed to its tightest in years.

The lookback verdict, written with the benefit of seeing this cycle in full, is that this was a textbook rerating story that completed in eighteen months what the market had refused to price for the prior three years. The next cycle, when it comes, will likely require a different catalyst. The cleanest read, from this side of August 2024, is that the era of effortless PSU bank outperformance had ended, and the more familiar pattern of private bank leadership had at least the conditions in place to reassert itself.