PSU Bank Stocks Face Correction Amid Budget 2026 and FDI Limit Clarifications

Introduction

The public sector banking sector in India witnessed a significant downturn as market participants reacted to a combination of fiscal announcements and regulatory clarifications. On February 1, 2026, the sentiment across the PSU banking space remained cautious, extending a period of volatility that began around the Budget 2026 presentation. While the broader markets have shown resilience, state-run lenders have faced specific headwinds that have led to a sharp re-evaluation of their short-term price trajectories. This correction comes after a period of significant outperformance, suggesting that the market is now entering a phase of consolidation and fundamental reassessment.

The Budget Day Trigger

The primary catalyst for the initial decline was the Budget 2026-27 announcements made by Finance Minister Nirmala Sitharaman. A key point of contention for the markets was the increase in the Securities Transaction Tax (STT) on derivatives. The tax on futures contracts was raised from 0.02% to 0.05%, a move that immediately dampened trading sentiment. This announcement led to a sharp reversal of early gains, with the BSE Sensex dropping below the 80,000-mark during afternoon trade. PSU banks, which often track broader market liquidity and sentiment, were among the hardest hit during this sell-off as traders adjusted their positions to the new tax regime.

Lack of Immediate Incentives

Beyond the STT hike, the banking sector was disappointed by the lack of specific incentives in the Budget. Analysts noted that there were no aggressive measures for PSU bank recapitalization or direct credit growth stimuli. Ponmudi R, CEO of Enrich Money, highlighted that the absence of these expected triggers led to widespread profit-booking. Investors who had entered positions in anticipation of sector-specific boons chose to exit, leading to a cascading effect on share prices across the board. The market had priced in a more aggressive support stance from the government, and the neutral tone of the Budget regarding banking reforms led to a cooling of enthusiasm.

The FDI Limit Clarification

Adding to the sector's woes was a crucial clarification from the Ministry of Finance regarding Foreign Direct Investment (FDI) limits. Speculation had been rife that the government might increase the FDI cap in public sector banks from the current 20% to 49%. However, Minister of State for Finance Pankaj Chaudhary unequivocally dismissed these reports in a written response to the Rajya Sabha. He stated that there is no proposal to raise the FDI ceiling, effectively puncturing the hopes of those expecting a surge in foreign capital inflows. This clarification removed a major speculative trigger that had been driving the recent rally in smaller PSU banks.

Market Performance and Index Movements

The impact of these developments was clearly visible in the sectoral indices. The Nifty PSU Bank index slipped significantly, marking multiple sessions of decline. On the BSE, the PSU Bank index lost over 285 points, settling at 4,807.19. This downward trend reflects a broader risk-off sentiment in financials, where investors are prioritizing safety over the high-growth narrative that dominated the PSU space in 2025. The index's fall below key support levels has triggered technical selling, further exacerbating the downward pressure on individual bank stocks.

Individual Stock Movements

The decline was broad-based, affecting both heavyweight lenders and mid-sized banks. The State Bank of India (SBI), the country's largest lender, saw its stock dive by 5.61%. Other significant losers included Bank of India, which fell by 8.41%, and Indian Bank, which saw a 7.30% decrease. Even banks like Punjab National Bank and Bank of Baroda, which had shown strong performance in previous quarters, were not spared from the selling pressure. The uniformity of the decline across the sector suggests that the movement was driven more by macro factors and policy sentiment than by individual bank fundamentals.

Summary of Stock Price Declines

Fiscal Deficit and Borrowing Plans

The government's borrowing plan for the next financial year also weighed on market sentiment. The Centre plans to borrow Rs 17.2 lakh crore to address a fiscal deficit projected at 4.3% of GDP. While the deficit figure shows a commitment to fiscal prudence, the gross borrowing target exceeded market expectations of Rs 14.80 lakh crore. This larger-than-expected borrowing plan has caused apprehension regarding liquidity and interest rate trajectories. Banks, as major holders of government securities, are sensitive to these borrowing targets, as they can influence bond yields and, consequently, the valuation of bank portfolios.

Strong Fundamentals vs Market Sentiment

Despite the current market correction, the fundamental health of PSU banks remains robust. In Q2 FY26, the sector reported a cumulative profit of Rs 49,456 crore, a 9% year-on-year growth. SBI alone contributed over Rs 20,000 crore to this total. Asset quality has also improved, with non-performing assets (NPAs) reaching multi-year lows. However, the market currently seems more focused on policy triggers and valuation consolidation than on these historical earnings. The disconnect between strong balance sheets and falling share prices suggests that the correction is primarily valuation-driven rather than a reflection of deteriorating asset quality.

Expert Analysis and Future Outlook

Analysts suggest that the current phase is one of healthy consolidation. Pravesh Gour of Swastika Investmart noted that the outperformance of PSU banks in 2025 warranted a period of cooling off. He advised that stock selection will now become critical, focusing on banks with consistent earnings growth and disciplined lending. The structural turnaround of the sector is still intact, but the era of rapid, sector-wide re-rating may be transitioning into a more selective growth phase. Investors are encouraged to look for banks with strong capital buffers that can withstand short-term volatility while benefiting from India's long-term infrastructure-led growth push.

Conclusion

In conclusion, the PSU banking sector is navigating a complex landscape of regulatory clarity and fiscal adjustments. While the denial of an FDI hike and the increase in STT have dampened short-term sentiment, the underlying financial strength of these institutions provides a cushion. The market's reaction to Budget 2026 highlights the sensitivity of state-run lenders to government policy and macro-fiscal targets. Investors are likely to adopt a wait-and-watch approach, looking for the next set of quarterly results and policy cues to determine if this correction presents a long-term buying opportunity or a signal for further caution. For now, the focus remains on stability and selective positioning within the sector.