Are India ETFs A Risky Play? [WisdomTree India Earnings Fund (ETF), EGA Emerging Global Shares Trust]

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May 19, 2014 4:01pm NYSE:EEM NYSE:EPI

indiaAfter months of global speculation and opinion polls on India’s multi-phase general election, Bharatiya Janata Party (BJP) — led by Narendra Modi– has finally emerged a clear winner. According to the election results on May 16, BJP alone will likely

win around 280 seats, accomplishing the 272 goal – the minimum number required to form the government in India.

Most importantly, this landslide victory will give BJP the governing power without any coalition. India will see a majority government for first time since 1984.

BJP’s prime minister candidate, Narendra Modi – the chief minister of the state of Gujarat for three terms – is seemingly a pro-growth politician. Under his leadership in the 2000s, Gujarat grew at a rate of 6.9% against the national average of 5.6%.

The world is now expecting Modi to reproduce his ‘Gujarat-model’ on the national level and free India from sky-high inflation, slowing growth, current account deficits, lower per-capita income and massive corruption. Last year, Goldman Sachs also “modi-fied” or rather upgraded its view on India on Modi’s potential win (read: India ETFs in Focus on Goldman’s Upgrade).

In fact, the Indian market has been taking one lap after another in its bull run since the beginning of this year on the hearsay of a governance change and finally hit an all-time high on hopes of ‘Modinomics’ at the time of writing in the intraday trading session on May 16.

A barrage of foreign capital inflows and a weaker dollar had pushed the Indian currency rupee to the 9-month high level against the US dollar.  After sinking to 69 per dollar, Indian rupee has shot up to 58.72 on mid-day session.

This year, all the India ETFs have showered double-digit gains on investors. Small-cap ETFs benefitted the most as this capitalization is normally sensitive to domestic events. Two small-cap India ETFs – India Small-Cap Index ETF (SCIF) and India Small Cap ETF (SCIN) –are up 23.4% and 21.4%, respectively.

How Long Can Modi Pull Up India ETFs?

While the global market seems completely mesmerized by Modi, it should also consider the other factors that contributed to India’s bull run. India’s policy to tighten gold imports has done a lot to contain the nation’s current account deficit this year.

The rupee also brightened up in the past few months on a slightly subdued dollar. Some of the country’s central bank’s measures, including rate hikes, also pulled up India’s economic indicators to some extent.

While there is no doubt that Modi’s win will favor some reformative measures in India in the coming days, some analysts see this publicity as overblown. According to them, although Gujarat’s performance was pretty strong in the last decade, states like Maharashtra had better growth figures.

Even underdeveloped regions like Bihar and Uttarakhand saw higher growth, per the source. Moreover, even before the Modi regime, Gujarat was doing well. The state reported 4.8% growth in 1990 against the national growth rate average of 3.7%.

Stubborn inflation is one of the biggest culprits of India’s bleak economic picture.  Notably, India’s April consumer inflation of 8.59% is hovering at a three-month high level due to flared up food costs.  In fact, thanks to the recent prediction of poor monsoon this year, India is due for another round of food price inflation in the coming months.

India’s industrialists hope for some rate cuts by Modi who is perceived as an investment-friendly leader, but the heightened inflation might come in that way. India’s key benchmark interest rate is presently 8%.  Any cut in key interest rate will blow up the inflation numbers (read: India ETF in Focus on Recent Rate Hike).  Also, industrial output was sluggish in the past few months resulting in softer GDP growth.

Added to these, the influence of global issues on the emerging markets is undeniable. The most serious among these is the fear of an eventual interest rate hike in the U.S. that would prompt massive emerging market sell-offs. And currency woes and current account deficit concerns will also be back then.

In such a conflicting scenario – somewhat similar to the Brazilian economy – investors would like to see how the Modi government spurs economic growth. While Modi does not surely have any magic wand to tackle these core issues overnight, even gradual recovery or at least the announcement of some reformative measures would spread cheer among investors.

Market Impact 

No doubt, India ETFs are at present trading at an exorbitant valuation having topped the entire emerging market equities ETFs table in the past one month frame.  Also, even after a sweeping win, much of the Modi-mania seems to have already been reflected in India ETFs. And we believe there is not much room for further run. The hope bubble could burst soon.

At the time of writing, SCIN added 5.32% in pre-market hours, WisdomTree India Earnings (NYSEARCA:EPI) added 2.80% and SCIF added 4.98% following the news of Modi’s colossal lead. But how long will the rally continue? It has to end somewhere.

Bottom Line

India ETFs will now be risky to play. So investors with a strong risk-appetite can stick to these ETFs and those with weak nerves should book profit. Most of the ETFs have reached an overbought territory.

Though there are still some hopes as our Buy-ranked ETF (NYSEARCA:SCIN) is trading at a lower trailing 12-month P/E ratio than the biggest emerging market ETF iShares MSCI Emerging Markets (NYSEARCA:EEM), implying some more gains. More than Modi, the end of a government under which the Indian economy started to slump should give a new lease on life in the coming days.

The risks are, however, quite high as the market is not at all cheap. It is advisable to leave the market now with the profits that it offers. And since BJP’s single-handed historic victory should bring all its promised growth-reforms without any resistance, this economy should offer many new money-making opportunities.

This is only the start of the Modi era, and investors can enter again when the new government shows fresh growth avenues.

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