Christian Magoon: India ETF investors had another piece of baggage dumped on them as S&P downgraded their outlook on India from stable to negative on April 25th. India currently is clinging to  a credit rating of BBB-, the lowest investment grade rating from S&P. Wednesday’s change in outlook means there is now a 33% chance India will lose its investment grade rating from S&P. This would significantly increase borrowing costs for the Indian government and state owned enterprises hampering economic growth.

S&P cited concerns about India’s fiscal deficit, slowing GDP and lack of progress in reforms to the many issues – including taxation, subsidies and foreign investment restrictions – by the government. On this news the India Rupee continued its downward slide against the U.S. Dollar. This slide is now likely to reach the late 2011 lows which caused considerable economic pain within India. Here’s the six month chart of the Indian Rupee in U.S. Dollars.

For India ETF investors, the continued devaluation of the Indian Rupee in response to the downgrade is a double whammy.  The downgrade fans negative investor sentiment, which is a bad omen for the foreign investment flows India depends on. In addition the rupee’s slide makes it harder for the India economy to grow. For example, India’s GDP growth rate has averaged 6% over the last five years and now S&P is forecasting a decline to 5.3% for the next Indian fiscal year. A robust economic growth rates has historically attracted investors to India and helped the country sweep other issues under the rug. Now that the growth rate is slowing, investor flows will likely decrease at the same time scrutiny of India’s economic and political issues grows. This is not a favorable combination for investors in India.

India ETF products began the year strong but now seem to be succumbing to the economic and political baggage piling up in India. Here’s a chart of the largest India ETF (NYSEARCA:EPI), the best performing India ETF in 2012 year to date (NYSEARCA:SCIF), and a broad based India ETF (NYSEARCA:INDY). Notice the declines from late February highs this year as economic data, election results and the new India budget began to drag down market sentiment.

Specifically, the decline since late February has pushed these India ETF products, a solid representation of the peer group, downward by more than 10%. This correction continues appears on track to move to a bear market unless a catalyst emerges. Below is the current performance since the February 21st descent.

Investors in India ETFs may have seen their best days of 2012 already. The momentum in Indian markets appears to be negative in the near term. Like 2011 did for early 2012,  valuations will eventually over correct and set up an opportunity for significant upside. After all, every non leveraged India ETF is still well into positive territory as evidenced by the India ETF performance grid from IndiaETFs.com below.

For now however, it appears S&P’s downgrade is just another reason to underweight exposure to India ETF products. Hopefully for Indian markets, the Indian government uses this warning from S&P to execute on needed reforms and return India to the growth engine it has been in the past.

Written By Christian Magoon From Magoon Capital

Christian Magoon is Publisher of GoldETFs.biz and IndiaETFs.com. He is also CEO of Magoon Capital, a strategic consultant firm to asset managers. Christian Magoon is an ETF insider, having launched over 40 ETFs in the United States to date. A widely recognized thought leader on finance and market issues, Christian regularly contributes to many financial media outlets. Prior to forming Magoon Capital in 2010, Christian was President of Claymore Securities (now Guggenheim Investments), where he built one of the fastest growing and most innovative ETF businesses in the country, gathering more than $3 billion in AUM in three years. He launched more than 40 ETFs, introducing many “firsts” to the U.S. market, including the first Frontier Markets, Sector Rotation, Solar Energy, Timber, BRIC and suite of China focused ETFs. Christian consistently provides his industry insights and knowledge as a commentator in the U.S. media speaking publicly on macro investment issues and ETF related topics. In 2008, he was named by Institutional Investor News as one of the five people to watch in the U.S. ETF marketplace. In 2011, Financial Planning magazine dubbed Christian an “ETF Pioneer.”

NASDAQ:INDY, NYSE:EPI, SCIF