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India ETFs Rebound on Central Bank Steps

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Indian ETFs have been among the worst performing emerging markets ETFs this year. The country’s stock market is now down 4.4% year-to-date and the currency has taken a bigger hit—down about 20% against the US dollar this year. The currency and stocks staged a nice recovery on Thursday after renowned economist Dr. Raghuram Rajan took over as the governor of the central bank of India.

Did the New Reserve Bank of India Governor Re-ignite Hopes?

Dr. Rajan surprised the market by announcing a series of measures within hours of taking office. The Indian Rupee recovered to 66 per dollar from 67 on the previous day and after touching a record low of about 69 per dollar last week.  The Bombay Stock Exchange’s Sensex gained 2.2%, with bank stocks being the top gainers.

Among the measures announced by the new governor to help the rupee were allowing banks to swap the dollars received in foreign currency deposits for rupees from the RBI and doubling the amount of money that banks can raise through overseas bonds, which can again be swapped for rupees. (Read: 3 Cyclical ETFs for an Improving Economy)

Dr. Rajan also laid out a road map to make the Indian banking sector more open and competitive. He further said that he was committed to liberalizing the financial market, strengthening the financial infrastructure and reducing restrictions on foreign investments.

The new governor, best known for his 2005 presentation at a Jackson Hole Symposium, wherein he warned about the financial crisis, has little experience with monetary policy setting. Further, the central bank has no control over structural problems plaguing the economy like widening budget deficits, crumbling infrastructure and increasing corruption.

Some of the measures announced by the central bank last month had obviously backfired as foreign investors feared that the country may impose more capital controls in future. It remains to be seen whether the new governor will roll back those measures. (Read: 3 Country ETFs to buy on an Oil Surge)

India ETFs Cheer RBI Measures

Popular ETFs tracking the Indian equity market—WisdomTree India Earnings (EPI - Free Report) and PowerShares India ETF (PIN - Free Report) surged 5.5% and 6.8% respectively yesterday, howver both of these are still down about 29% year-to-date. Small-cap India ETFs like Market Vectors India Small Cap ETF (SCIF - Free Report) ) and EGShares India Small Cap ETF (SCIN - Free Report) ) which have been terrible performers this year, down more than 30% year-to-date, also recovered by more than 4%.

Macroeconomic Fundamentals Worsening

India’s widening current account deficit is the biggest concern for foreign investors. The country depends on foreign capital inflows to finance that deficit. However billions of dollars that went to the country in search of higher yield have now started coming back thanks to rising interest rates and an improving US economy. (Read: Indonesia ETFs Surge on Surprise Rate Hike)

India is a big importer of oil and the recent surge in oil prices combined with the decline in the currency will worsen the deficit further. Further even though the country’s foreign exchange reserves stand at more than $275 billion, the currency remains vulnerable to short-term capital flows.

The Indian economy grew at just 5% during 2012-13 fiscal year, lowest in a decade and significantly below ~8% average growth rate achieved during 2006-11. Growth further slowed to 4.4% during the quarter ended June 2013 from 4.8% in the preceding quarter. The IMF expects the economy to grow at 5.7% in 2013. Many other agencies expect the growth rate to be much lower.

Is there Any Hope for the Economy?

Among the positive developments, exports have been rising recently as a result of weak rupee and gradual recovery in global economy. India’s IT sector in particular stands to benefit from these two factors. Indian banks, which have been beaten down in the recent past on account of rising bad loans, also surged impressively yesterday on the back of new measures announced to improve the banking system.
Further, taxes on gold imports have been able to bring down gold imports, which are a significant factor in current account deficit, which widened to 4.8% of GDP in the fiscal year ended March. 

The Bottom Line

While the sell-off in emerging markets seems to be over-done and they seem to be stabilizing now, investors will need to be more careful in picking the right countries and sectors from that space. Indian stocks and ETFs may get a bounce in the short-term, but the longer-term prospects for the economy do not look bright.

In addition to structural problems like chronic inflation (close to 10%), widening deficits, massive corruption and crumbling infrastructure, the country suffers from slowing growth now. Several populist measures announced by the government recently, with an eye on general elections next year, will only worsen the public finances situation.

Unless the government shows political resolve to address the structural problems affecting the economy, the outlook for India ETFs remains rather cloudy as of now. But with general elections due next year, the chance for some major reforms is rather slim now.

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