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India ETFs After the Surprise Rate Hike

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Last week, the Fed surprised financial markets by not tapering its asset purchase program. Indian stocks rallied on the surprise move by the Fed. Also, the Indian rupee strengthened against the U.S. dollar on better outlook for foreign inflows.

However, after soaring on the Fed’s surprise move, came the Reserve Bank of India’s unexpected rate hike. Indian financial markets were roiled when the Reserve Bank of India unexpectedly raised the key policy rate by 25 basis points to 7.5%, triggering a big move country's currency, shares and bond prices. The BSE Sensex slumped 382 points, or 1.85%, to end at 20,263, snapping its four-day winning streak (India ETFs--Is the Worst Over?).

Slow growth of the economy, high inflation and weakened currency were reasons cited for the RBI’s surprise move. Growth slowed to a decade low of 5% in the year ending March and was at 4.4% in the April-June quarter. The inflation rate in India was recorded at 6.10% in August of 2013.

Economic Problems

India is suffering from a host of economic problems. These include poor infrastructure and stubborn inflation that keeps interest rates high, dependence on imported fuel, a current account deficit due to low exports and high imports, and fragile confidence that has deterred business investment.

Additionally, the government's budget is in deficit thanks to costly fuel subsidies and the fiscal position that is likely to deteriorate because of the looming cost of a new law guaranteeing food for the poor (India ETFs Rebound on Central Bank Steps).

Stimulus Program

India is also planning to start its quantitative easing program in order to provide a boost to overall growth. In its endeavour to provide quantitative easing, RBI will purchase commercial paper of companies of certain sectors. Target sectors include small and medium enterprises, engineering goods and commercial vehicles.

The stimulus program will assist in restoring the waning growth of the economy without undermining the central bank’s inflation focus.

Impact on ETFs

ETFs focusing on India tumbled after the RBI unexpectedly increased interest rates with the motive to control inflation.  One of the ETFs with Zacks Rank of 3 ‘Hold’, WisdomTree India Earnings Fund (EPI), lost 2.8% in the last trading session. EPI is by far the largest ETF in terms of asset base and also the most liquid fund tracking Indian equities (India ETFs--Behind the Mayhem).

The fund offers a broader play in Indian equities as it holds a portfolio of 188 securities and appears to be concentrated in the top 10 stocks where it has invested 50.03% of its assets.

Among individual holdings, Reliance Industries, Infosys and Oil and Natural Gas Corporation form the top line of the fund and together account for almost 25.2% of the allocation. The fund charges an expense ratio of 83 basis points on an annual basis.

Another ETF, iShares S&P India Nifty 50 ETF (INDY), closed down 3%. The product has amassed a net asset base of $421.3 million. The fund’s asset base is spread across 51 Indian securities and does little to reduce company specific risk as more than 58.8% of the asset base goes towards the top ten (Zacks Top Ranked India ETF in Focus: INDY).

ITC Limited (9.97%), Reliance Industries Limited (7.46%) and Infosys Ltd (7.42%) are the three top elements in the basket.

Among sectors, banks are the first preference of the fund as they make up a substantial portion of the basket with a share of 19.9%. The ETF is extremely pricey with an expense ratio of 93 basis points a year.

Yet another ETF that dwindled on the surprise rate move by RBI is PowerShares India Portfolio (PIN). The fall in PIN ETF price was comparatively more than the other two ETFs discussed above. The fund closed the day falling 3.51%.

The fund has built an asset base of $359.1 million since its inception and provides exposure to 51 Indian securities. These 49 securities are mainly from energy, information technology  and financial sectors in which the fund assigns more than 60% of the asset base in total (Does Your Portfolio Need An India ETF?).

Among individual holdings, Reliance Industries (9.96%), Infosys (9.64%), and Oil & Natural Gas Corp (7.95%) occupy the top line of the fund. The fund appears to be a bit more reasonable than INDY, charging a fee of 81 basis points from investors.

Bottom Line

The Indian capital market is more dependent on foreign institutional investment (FII) for its growth. Investors should note that after Raghuram Rajan took over as the new Reserve Bank of India governor, FIIs seem to have resumed buying Indian equities. Until last week, FIIs had bought $1.7 billion worth of shares. This should positively boost the Indian capital market.

Additionally, RBI measures to control inflation and quantitative easing program should provide further support to the growth of the economy. However, it is advisable that investors should wait for further evidence before investing in the economy, though recent trends are certainly encouraging, especially if the moves get the problems under control.

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