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Like many other emerging economies, concerns over the Indian economy have been mounting since the beginning of the year as the nation is grappling with internal and external economic issues. Plagued with slowing economic growth, persistent sky-high inflation, lower per-capita income and massive corruption, the country is now experiencing the real pain from a weakening currency. As a result, a lot is being written and said about it.

The Indian rupee hit an all-time low of 61.21 to a dollar due to a massive sell-off in the emerging market currencies after the U.S. Fed chairman Ben Bernanke’s earlier hint regarding curtailing the easy monetary policy later this year. The currency depreciated 13.5% over nine weeks against the dollar. A general risk-off trade, the recent firmness in the dollar and a wide current account deficit resulted in the currency’s weakness.

However, the rupee had recovered a bit after Fed’s dovish comment to continue with accommodative monetary policy in the near future.  The currency recovered further and reached its two-week high after the central bank announced some tough measures to stem the slide.

The measures taken by the Reserve Bank included increasing the interest rate on its short-term liquidity window by two percentage points to 10.25% and capping its daily liquidity window at 750 billion rupees.

In addition to raising short-term borrowing costs and restricting funds available to banks, the central bank also announced that would sell Rs 120 billion in bonds, effectively draining liquidity from the market. While these measures were successful in halting the fall in short-term, they will affect economic growth in the longer-term.

Why Tumbling Rupee is a Key Concern?

India has a huge domestic market and barring a few sectors like gems and jewelry, textiles, software, engineering goods, it is not an export oriented economy as a whole. On the contrary, high levels of oil import are resulting in continued trade deficits over the years.

As per tradingeconomics, India recorded a trade deficit of 1108.11 INR billion in May 2013. Over the last four decades, its best trade performance was a surplus level of 13.91 INR billion in April 1991. Apart from Indonesia, India is another Asian country to face a current account deficit. In such an import-centric scenario, continued stress on the currency is not surprising at all.

Weak exports also do not make India immune to economic contagion from developed nations as most of its export-partners like Eurozone and China are reeling under pressure (Read: China ETFs Tumbling on Fears of Credit Crunch). This has substantially marred Indian exports because of reduced demand. Thus, India keeps on witnessing current account deficit, higher than the tolerance level, eating up the forex reserve and thus depreciating the rupee.

Fallout

India’s inflation rate is stubbornly high, above 10%, for more than one year now.  As of May 2013, India’s consumer price index stood at 10.68%, up 44 bpssequentially and 52 bps year over year. A continued fall in rupee will further aggravate inflation.

Last but not the least, a weak rupee is sure to mar profits of companies with high ECB exposure.

Quite expectedly, owing to such shocks, India ETFs have been struggling this year, plunging double digits in the year-to-date timeframe. Some popular ETF choices that have been crushed so far this year include Wisdom Tree India Earning Fund (EPI - ETF report) losing 19.4%, PowerShares India Portfolio (PIN - ETF report) shedding about 14.1%, iShares S&P India Nifty 50 Index (INDY - ETF report) and iShares MSCI India (INDA - ETF report) being beaten down by about 13.3% and 10.5%. All above-mentioned ETFs underperformed SPY in the past six months.

Is there Any Hope?

The current account deficit (CAD) data for the first quarter signals a ray of hope which actually narrowed down to $18.1 billion from the lofty levels of $31.9 billion in the previous quarter. It was a sharp moderation in CAD to 3.6% for the March quarter from 6.7% in the previous quarter. Further, the rate is now not much higher than the 2.5% comfort zone of the Indian central bank.

Second, while consumer inflation still remains firm, the wholesale price index softened to 4.7% in May indicating a third straight month of decline. In fact, the rate is now within RBI’s comfort zone of 5.0%.

Third, the Fed’s comment that it will continue with easy monetary policy should calm anxious investors and lead to a quick shift in risk perception.

Fourth, the abundance of technically skilled manpower put India’s outsourcing business on fast track for the past few years. A weakened currency will likely take this booming industry a step ahead.

Finally, policy easing on foreign direct investment since last September is being implemented to attract a large influx of capital.  

Bottom Line

Even though the estimates hold up, India still remains a strong growth vehicle in the global map. Although cut from the prior level, latest projections for India’s growth in 2014 of a respective of 5.8% and 6.1% by IMF and World Bank are still quite high when compared to many of its western as well as eastern counterparts (read: Forget China, Buy These Emerging Market ETFs Instead). A set of reformative measures, aimed primarily at building an investor-friendly climate have actually created a buzz in the recent months (see more ETFs in the Zacks ETF Center).

While a plunging currency has sent the Indian market on pins and needles lately, leaving little scope of improvement anytime soon, we can look at the attractive valuation as an indication of a good entry point to Indian ETFs for risk-tolerant investors (Read: India ETFs: Back on Track?).

Investors might also want to consider positive factors like a rising middle class and a younger population with growing spending power as these would result in soaring domestic consumption and economic growth. Considering these, the India ETF outlook—at least over the long term—isn’t as grim as one might think.

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