Will Fourth Rate Cut In 2019 At All Help India ETFs Recover?

India ETFs have been under pressure over the past three months (as of Aug 6, 2019) mainly on a volatile global market backdrop, a rising U.S. dollar, slowing economic growth, irregular monsoon and a liquidity crisis in the shadow banking sector.

After a month-long, multi-phase election, which spanned from Apr 11 to May 19, prime minister Narendra Modi-led Bharatiya Janata Party (BJP) has secured the second term. Since Modi is viewed as a market-friendly leader, India’s key equity gauges SENSEX and Nifty crossed 40,000 and 12,000, respectively, for the first time and led to gains in India ETFs only to slump in the ensuing months (read: International ETFs Win in May).

iShares India 50 ETF (JK:INDY) was down 5.8% in the past three months (as of Aug 6, 2019) as the U.S. dollar ETF Invesco DB US Dollar Index Bullish Fund UUP has risen 1.1% in the past three months. This underperformance happened despite the Reserve Bank of India’s (RBI) dovish stance.

On Aug 7, RBI slashed repo rate for fourth time this year as benign inflation gave the central bank a leeway to resort to easy money policy to boost an economy that is expanding at its slowest in nearly five years. At 3.18% in June, India's retail inflation has remained below the central bank's medium-term target of 4% for about a year.

In the latest cut, repo rate was lowered by 35% basis points to 5.4%. The cut was sharper than expected as about 80% of 66 economists surveyed by Reuters expected the RBI to cut its benchmark repo rate by 25 bps while three forecast a 50-bps cut.

Why India ETFs are Struggling Despite Back-to-Back Rate Cuts

The RBI recently lowered the GDP growth rate for 2019-20 to 6.9%, as compared with the earlier estimate of 7%. But previous rate cuts seem not to have boosted economic growth materially.

Per fresh RBI data, “banks disbursed retail loans at the slowest rate in five years in the first half of 2019, amidst growing concerns of sluggish consumption demand and rising unemployment pegging down the country’s economic growth.” Banks, struggling with bad debt, appear cautious to lend out despite the RBI's indulging.

Corporate earnings have been weaker. There were most-disappointing quarterly numbers from Indian companies in at least three years. “More than 60% of 125 firms that have reported so far, and are tracked by analysts, missed profit forecasts for the June quarter, the most since at least 2016, Refinitiv data shows.”

An irregular monsoon is detrimental to India’s economic growth. India’s agriculture sector makes up about 14% of the country’s $2.7 trillion economy and 42% of total employment, per chief economist in Asia Pacific for consultancy IHS Markit.

Per IHS, about one-third of India’s manufacturing output — which forms around 18% of Indian GDP — is related to processing agricultural products into food. Now, about 55% of India’s arable land is dependent on rainfall which was 33% below its 50-year average in June, according to Citi. This clearly shows why India’s growth outlook has turned gloomy in recent months.

There has been a flare-up in the political tension in J&K too. The scrapping of Article 370 tied to Kashmir under which the state used to enjoy its own separate constitution has also weighed on the Indian market this month. Rupee has also been struggling thanks to a host of negative news. India’s currency broke the 70-mark against the dollar and posted its biggest one-day slump in six years on Aug 5.

Any Hope Ahead?

No major tailwinds for Indian ETFs are in sight. However, Foreign Portfolio Investors (FPI) that were hit by the budget proposal to levy higher surcharge on income tax, may get some benefits. The government is now mulling over a plan to grandfather all income generated by FPIs. However, this measure is also a short-term one. Though the latest government stimulus is good for the markets, we are unlikely to see a sustained uptrend until the easy money policies materially boost economy and corporate earnings.

ETF Performance

Small caps have been underperforming large-cap India ETFs this year. Funds like VanEck Vectors India Small-Cap Index ETF SCIF and iShares MSCI India Small-Cap ETF (LON:SMIN) are down respectively about 15% and 11% in the past month and about 26.1% and 12.7% this year.

On the other hand, large-cap funds like WisdomTree India Earnings Fund (TSXV:EPI) , INDY and iShares MSCI India ETF INDA have shed about 6.8%, 1.1% and 4%, respectively, in the year-to-date frame. These funds are off 9.7%, 8.4% and 8.6%, respectively, in the past four weeks (see all Asia-Pacific (Emerging) ETFs here).

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