Will Latest Bank Fraud Impact India ETFs?

India has been falling prey to frauds and the latest is nothing short of a nightmare for public sector banks. The issue at stake is that if investors are not confident about the government’s operations and if the inherent risks with emerging market investments actually come true, foreign investors will think twice before assuming the risks that come with their investment.

Into the Headlines

India’s public sector banks have been witnessing a decline in share prices and market value, as diamond billionaire Nirav Modi has been accused of perpetrating a fraud to the tune of INR 110 billion ($1.8 billion) along with some members of the state-run Punjab National Bank (PNB).

Nirav Modi wished to import pearls and diamonds to make jewelry, for which he planned on taking loans from overseas banks because of the lower interest rate. Such loans are initiated after a letter of undertaking (LoU) is issued by the bank to overseas banks on behalf of its customers. However, for some reason, Nirav Modi was not required to fulfill the margin requirements generally needed to get these loans sanctioned and that’s how this scam began.

In the first week of February 2018, PNB informed India’s regulators of an INR 2.8 billion fraud as the story around illegitimate LoU’s unfolded. By the next week, this figure reached INR 110 billion, dropping a bomb on the share prices of India’s banking sector.

While the roots of this fraud can be traced back to 2011, multiple Indian banks have stated their exposure to the fraud. As this fraud was developing, the government was pumping in taxpayer money to the ailing second largest state-run bank of the country, PNB. This has spooked investors, as they remain wary of how a scam of this magnitude went undetected for almost seven years. This is the second such case in recent times, as Vijay Mallya fled the country after defaulting on INR 90 billion worth of loans in 2016.

Economic Scenario

Coming to the economic data points, India’s GDP grew 6.3% year over year in the third quarter of 2017 compared with a three-year low of 5.7% in the previous quarter. The central bank revised its GDP estimates for fiscal 2017-18 as well as 2018-19. RBI expects the Indian economy to grow 6.6% in 2017-18 and 7.2% in 2018-19, in terms of Gross Value Added – GVA (read: India ETFs in Focus on Union Budget Release).

There has been a net outflow of INR 65 billion of foreign institutional investor money in the first 15 days of February, driven by the global market sell-off as well as other India specific factors. We believe, the Narendra Modi government has to take a strong stand against such cases, in order to regain confidence in the economy and to remain in power ahead of the 2019 general elections (read: India ETFs in Focus as Central Bank Holds Interest Rates).

Prompt action by the leading financial institutions of the country such as the Reserve Bank of India (RBI) could have identified the fraud earlier and perhaps could have avoided losses and financial damage to the government to some extent.

Let us now discuss a few ETFs focused on providing exposure to the emerging market nation (see all Asia-Pacific Emerging ETFs here).

iShares MSCI India ETF INDA

This fund provides exposure to large and mid-sized Indian equities.

It has AUM of $5.5 billion and charges a fee of 68 basis points a year. Financials, Computer-Software and Consumer Discretionary are the top three sectors of the fund, with 22.9%, 13.8% and 12.3% allocation, respectively (as of Feb 15, 2018). Housing Development Finance Co, Reliance Industries Ltd and Infosys Ltd are the top three holdings of the fund, with 9.2%, 8.1% and 6.5% allocation, respectively (as of Feb 15, 2018). The fund has returned 22.2% in a year. INDA has a Zacks ETF Rank #1 (Strong Buy), with a Medium risk outlook.

WisdomTree India Earnings Fund (V:EPI)

This fund provides exposure to Indian equities in multiple capitalization segments.

It has AUM of $1.8 billion and charges a fee of 84 basis points a year. Financials, Energy and Information Technology are the top three sectors of the fund, with 23.0%, 18.8% and 18.1% allocation, respectively (as of Feb 16, 2018). Reliance Industries Ltd, Infosys Ltd and Housing Development Finance Co are the top three holdings of the fund, with 9.0%, 8.1% and 6.2% allocation, respectively (as of Feb 16, 2018). The fund has returned 24.8% in a year. EPI has a Zacks ETF Rank #1, with a Medium risk outlook.

iShares India 50 ETF (JK:INDY)

This fund provides exposure to large-cap Indian equities.

It has AUM of $1.2 billion and charges a fee of 93 basis points a year. Banks, Computer-Software and Refineries/Marketing are the top three sectors of the fund, with 26.2%, 11.1% and 10.5% allocation, respectively (as of Feb 6, 2018). Reliance Industries Ltd, Housing Development Finance Co and ITC Ltd are the top three holdings of the fund, with 7.9%, 7.2% and 5.6% allocation, respectively (as of Feb 15, 2018). The fund has returned 22.2% in a year. INDY has a Zacks ETF Rank #1, with a Medium risk outlook.

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