Are India ETFs in for a Rough 2017 Thanks to Modi?
India ETFs – once a hot investment destination on pro-growth political changes in 2014 – have had a downbeat 2016. Hardly any fund is in the positive zone this year. Let’s take a look at what hit India ETFs this hard.
Demonetization
The event that put the Indian economy on global headlines of late was currency demonetization in early November, when as much as “86% of Indian currency and 12% GDP got stalled overnight.” As per the announcement, the Indian government withdrew high-denomination banknotes – 500 rupee and 1000 rupee notes – in circulation, as part of a crackdown on illegal money, dealing a heavy blow to the finances of militants targeting India.
The immediate impact will be on inflation as eradication of unaccounted and untaxed money will have a deflationary effect. Some even view the step as an unplanned form of policy tightening, though India has been resorting to rate cuts in recent times to boost growth (read: 4 India ETFs to Buy as RBI Cuts Rate).
With the demonetization move, the Indian economy is presently going through a cash crunch. Some analysts in fact have cut India’s GDP growth forecasts. Fitch rating reduced India’s GDP forecast to 6.9% from the prior estimate of 7.4% for the current financial year while Bank of America Merrill Lynch slashed forecasts by about 50 bps to 6.9% for fiscal 2017.
Trump Win & Fed Hike
If this was not enough, Donald Trump’s win is likely to cause uncertainty in the coming days for a few foreign economies including India. This is because Trump has a harsh stance on immigration and offshoring in his campaign. With outsourcing making up about 20% of India’s exports of goods and services, uncertainty looms large for India.
Plus, the Fed enacted its second rate hike in almost a decade in mid-December and plans to pass three more in 2017 as of now. As a result, the greenback and the U.S. treasury bond yields are on an uphill ride. This in turn is likely to mar the relatively higher-yielding emerging market securities, like those tied to India (read: Sole Fed Hike of 2016 Put These ETFs in Focus).
Is a Hike in Capital Gains Tax Likely?
Added to the demonetization, prime minister Narendra Modi recently indicated a hike in taxes on stock market income. As per media reports, he noted that with tax payments from capital gains being low, “there’s a need to find ways to ensure levies are raised.”
Investors should note that at present the profits earned on the sale of shares after holding them for over a year, are tax exempted. But profits made from the sale of shares held for below a year are taxed at 15%.
Needless to say, markets took a hit with the double whammy of cash crisis and a likelihood of a raise in taxes. Though India’s finance minister elucidated “that the government had no such plans” and the interpretation of the prime minister’s statement “is absolutely erroneous” it could not shove skepticism from the market. Finance minister rather insisted that “India needs lower taxes to be globally competitive.”
Whatever the case, overseas investors have already offloaded about $500 million of Indian stocks this month, following a $2.6 billion net depletion from the market in November, as per Bloomberg.
Will 2017 be as Painful?
India ETFs are likely to feel the pinch in the initial phase of 2017, at least until the Union Budget 2017 is released in early February when investors can gain an insight into where the economy is headed. As far as the threat for long-term capital gains are considered, the finance minister’s statements indicate that no such move is expected in the near future.
On a positive note, Moody's indicated Indian companies are to witness “the strongest profit growth over 18 months.” Plus, deflationary impact caused by demonetization makes it easier for the Indian central bank to opt for rate cuts in the future. Now, it would be interesting to see if India ETFs like WisdomTree India Earnings ETF (EPI) can survive the demonetization in 2017 (read: What Lies Ahead for India ETFs?).
However, investors should stay away from the funds catering to the consumer, small-cap and infrastructure segments, namely – Columbia India Consumer ETF INCO, iShares MSCI India Small-Cap SMIN, Columbia India Small Cap ETF SCIN and Columbia India Infrastructure ETF INXX. These funds bear the direct impact of the demonetization (read: India ETFs Tangled Between Note Demonetization & Trump Win).
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ISHARS-M IND SC (SMIN): ETF Research Reports
COL-INDIA CNSMR (INCO): ETF Research Reports
COL-INDIA INFRA (INXX): ETF Research Reports
COL-INDIA SC (SCIN): ETF Research Reports
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