FPIs reduce Bank Nifty shorts ahead of RBI policy, signalling potential rally

This unwinding of bearish bets aligns with market expectations of a 25 basis point repo rate hike to 5.50%, the first in over three and a half years, while the RBI maintains its neutral stance. Analysts note that the rate increase and policy stance are already priced in, with investors now watching for any surprises that could derail a potential rally.

Short covering typically supports upward pressure on underlying stocks as positions are closed. Market experts suggest that continued unwinding, combined with improving credit prospects and strong liquidity from FCNR(B) deposits, could fuel a near-term rally in banking stocks.

The Bank Nifty index, which had fallen 6% from 57,701 on 7 September to 54,175 on 29 September due to heavy shorting, has since recovered. It rose 1.5% to 54,923 on Monday and a further 0.6% to 55,271 on Tuesday, indicating sustained buying interest.

Analysts attribute the rebound to oversold conditions, improving credit growth, and the potential for banks’ net interest margins to benefit as loan rates reprice faster than deposit rates following a repo rate hike.

FPIs’ overall net short position in index futures, including Nifty and Bank Nifty, declined to ₹54,444 crore on 5 October from ₹62,706 crore on 25 September, suggesting broader position adjustments beyond banking stocks.

Despite the reduction, FPIs’ hedging activity in index futures remains a small fraction of their total Indian equity exposure. At end-September, FPIs held ₹66.17 trillion in Indian equities, with financial services accounting for ₹20 trillion. The ₹55,000 crore net short in index futures represented only about 0.8% of their total portfolio, indicating limited hedge impact.

Market participants caution that any deviation from expected policy outcomes or sudden escalation in global tensions, such as in the Middle East, could reverse the current optimism. For now, the bias remains cautiously positive, contingent on a smooth policy outcome and absence of negative surprises.