PSU bank stocks held the market's attention in morning trades on Tuesday as there's much anticipation that the Union Budget for 2003-04 may bring about the raising of foreign holding ceiling in these banks.

The stocks that showed strength were Union Bank (up 2.20% to Rs 25.50), SBI (up 1.51% to Rs 313), PNB (up 1.72% to Rs 83), Corporation Bank (up 1.85% to Rs 143), Bank of India (up 2.21% to Rs 37), Bank of Baroda (up 2.81% to Rs 75), Canara Bank (up 2.42% to Rs 65.70), Dena Bank (up 2.66% to Rs 13.50), Oriental Bank of Commerce (up 1.97% to Rs 56.80) and Andhra Bank (up 1.69% to Rs 27).

These stocks were fueled by hope that the government will raise the cap on foreign fund holdings in PSU banks to 49% from the currently prescribed ceiling of 20%. The Union Budget will be released on 28 February 2003.

Banking stocks are also firm as bond prices in the gilts market are picking up. Over the last few sessions, bank stocks were being offloaded on reports that interest rates may rise due to a drop in prices of government securities.

Banking analysts were concerned that if interest rates rise profitability of banks will be hit. Over the last year, subdued credit offtake and low interest rates had set off huge investments by banks in government securities. In FY-2001-02, 17 banks in the PSU banking sector had invested Rs 2,68,015.40 crore (Rs 2680.4 billion) in government securities, 18.7% higher than in the previous year. In the current financial year, investments are estimated to be even higher than that in FY 2001-02.

It is feared that if banks increase interest rates. The gilts market will be badly affected, as yield from gilts will fall. If banks are not now able to sell their government securities at reasonable prices, they may end up booking huge losses in the current financial year. As per latest reports, leading public sector bank Bank of Baroda raised deposit rates by 25 to 50 basis points, to 4.75% to 6.0% depending on maturities.

An interest rate hike may also be set off as the public is now keener to invest in real estate or gold, where returns are higher than from bank deposits. With deposits declining, government borrowings have also been hurt.

Therefore, there is talk that interest rates will be hiked at the behest of the government in order to guard investor interest as well as help the government meet its fiscal targets.

Meanwhile, it is also felt that banks may not aggressively sell their gilts portfolio at this juncture as it could affect their yields. It is only when banks see a major rise in interest rates and a revival of credit offtake that they may book profits on their investment in gilts.