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Once Again, Government Has India ETFs at Crossroads

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The stalemate has weighed on the common currency as investors fear Athens could go bankrupt.

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Year-to-date, the iShares S&P India Nifty 50 Index Fund (NASDAQ:INDY), the WisdomTree India Earnings ETF (NYSEARCA:EPI), and the PowerShares India Portfolio (NYSEARCA:PIN) are sporting an average gain north of 14%. The downside of those gains is that investors have had to endure a roller-coaster ride on the way to the bank as EPI and INDY both have volatility metrics above 25%. PIN rests at 26%.

As is the case in many other emerging markets, a large part of the reason for India's underlying volatility is the country's government and its role in day-to-day economic perceptions. After getting off to a fine start in the first quarter, India ETFs such as EPI, INDY, PIN, and others tumbled on speculation the country was primed to lose its already tenuous investment-grade credit rating.

At BBB- on the Standard & Poor's ratings scale, India has the lowest credit rating of the four the BRIC nations. In April, S&P lowered its outlook on that rating to negative, prompting some analysts and investors to say the government in Asia's third-largest economy had turned a blind eye to the country's economic woes.

Investors' fears would later be somewhat assuaged when the government once accused of doing nothing to bolster its economy and foreign investment gave investors reason to cheer. India ETFs would soar for most of the third quarter after the government unveiled an array of economic reforms aimed at stimulating growth and investment.

Those reforms included opening India's massive insurance and retail sectors to additional foreign investment, reduction of the country's punitive diesel subsidy, and the injection of added liquidity into the banking system.

Those headlines were enough to lift the fortunes of India ETFs and not just the well-known fare such as the aforementioned funds. The EGShares India Small Cap ETF (NYSEARCA:SCIN), the EGShares India Infrastructure ETF (NYSEARCA:INXX), and other India funds benefited from the government reforms.

Fast-forward to today and government that oversees the world's largest democracy is once again likely to have a heavy hand in near-term returns to India ETFs. India is grappling to keep its fiscal deficit to 5.3% of GDP in a bid to keep its investment-grade rating. The country is looking to pare the deficit 0.6% annually for the next five years, Bloomberg reported.

Whether or not traders are pricing in a credit downgrade for India can be debated, but what can not be debated is that the yield's on Indian 10-year sovereign bonds touched a two-month high earlier this month. The spread between those bonds and the comparable US Treasuries is about 650 basis points.

Despite the size of its economy, India is not nearly the bond issuer, either at the sovereign or corporate level, that China is. At the ETF level, that translates to small weights in some of the marquee emerging markets debt ETFs, meaning investors can get some exposure to Indian bonds without being excessively exposed to a potential credit downgrade. For example, the WisdomTree Asia Local Debt Fund (NYSEARCA:ALD) allocates less than 5.7% of its weight to India and that is one of the larger weights to Indian government debt offered by any US-listed ETF.

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No positions in stocks mentioned.

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