* Q4 net profit down 8 pct to $519.8 mln, ahead of estimates
* Bad loans fall sequentially, shares surge nearly 10 pct
* Indian banks betting on new govt to drive economy recovery (Adds management, analyst comments)
By Devidutta Tripathy
NEW DELHI, May 23 State Bank of India (SBI) , the nation's biggest lender, reported a drop in bad loans and quarterly net profit that beat forecasts, sending its shares to their highest level in three years.
Net profit for SBI, which accounts for about a quarter of India's loans and deposits, fell about 8 percent from a year earlier to 30.41 billion rupees ($519.8 million) for its fiscal fourth quarter to March 31, but was higher than 28.03 billion rupees estimated by analysts.
Lenders in India are betting a new government set to take over next week will help revive an economy facing its worst slowdown since the 1980s, spurring loan growth and checking a rise in bad loans.
India's economic growth has almost halved to below 5 percent in the past two years on weak investment and subdued consumer demand. Investors hope the new government led by Narendra Modi, who is seen as a pro-business leader, will speed up reforms and give faster clearance to big projects.
"We are all optimistic about the new government," SBI Chairwoman Arundhati Bhattacharya said at a news conference in the eastern city of Kolkata.
"We should grow as per the economy," she said. "Let us see how the economy behaves. The credit growth will come with a lag."
SBI, which is about 58 percent owned by the Indian government, this year pledged to increase scrutiny of bad loans by doing regular reviews and using new technology. It said gross non-performing loans as a percentage of total loans fell 78 basis points sequentially to 4.95 percent in the March quarter.
Manish Ostwal, a banking analyst at Mumbai brokerage K.R. Choksey Shares and Securities, said the reduction in non-performing loans was a "big achievement".
"These numbers look sustainable," Ostwal added.
SBI's net interest income rose 16.5 percent from a year earlier, while its domestic net interest margin was stable at 3.49 percent, the bank said.
Operating profit of 106.28 billion rupees in the March quarter was the bank's highest-ever, Chief Financial officer R.K. Saraf said.
Indian banks including SBI are expected to tap markets to raise funds to meet capital rules and shore up their battered balance sheets. An external central bank panel said this month that state lenders would need up to $98 billion in tier 1, or core capital by March 2018.
Bhattacharya said SBI would discuss with regulators and the Indian government about a possible share sale.
SBI saw a tepid response from foreign investors for a $1.28 billion share sale in January, largely because of concerns about its asset quality and earnings growth in a slowing economy.
Shares in SBI, valued at more than $32 billion, closed 9.6 percent higher, after hitting their highest level since May 2011. The stock has surged almost 56 percent this year, while the banking sector index has risen more than a third on hopes of a recovery in the fortunes of the sector.
($1 = 58.5050 Indian rupees) (Reporting by Devidutta Tripathy; Editing by Matt Driskill and Mark Potter)