Koesterich: Underweight India

In a recent blog post, Russ Koesterich, iShares Global Chief Investment Strategist, recommends investors underweight their exposure to India, Asia's third-largest economy. "I currently hold an underweight view of Indian stocks given India's slowing growth, stubbornly high inflation, large current account deficit and chronic budget deficit," Koesterich said on the iShares blog. The less-than-enthusiastic view of India is arguably well-timed. Earlier this month, Standard & Poor's said the "I" in the BRICS acronym is in danger of losing its investment grade credit rating. That news followed S&P's April move to lower its outlook on India's BBB- rating, the lowest on the investment-grade totem pole, to negative from stable. Koesterich points readers to a paper published earlier this month by the BlackRock Investment Institute, which highlights five trouble spots for the Indian economy. As Koesterich notes, those red flags are: 1. Fiscal and current account deficits are hurting India's capacity to finance growth. 2. High inflation and a weak rupee currency limit the Reserve Bank of India's (RBI) maneuvering room to cut interest rates, and current relatively high interest rates put a damper on economic activity. 3. Policy-making is slow-moving and erratic (thanks to a logjam of bills and official probes), and the probability of much-needed reforms in the near future is low. 4. Domestic consumption underpins India's 7% economic growth, but there are signs it's faltering. 5. As India is a major oil importer and is the world's No. 2 gold consumer, the country's current account can be negatively impacted by energy and gold prices. India's economic woes have already punished ETF's tracking the country. As speculation has swirled that Indonesia could replace India as the "I" in BRICS, India ETFs have plunged. In the past 90 days, the WisdomTree India Earnings ETF EPI, the largest India ETF by assets, has tumbled 16 percent. The iShares MSCI India Index Fund INDA has slid 13.7 percent and the iShares S&P India Nifty 50 Index Fund INDY has dropped almost 12 percent. Small-cap ETFs tracking India have been even worse in the past three months. The Market Vectors India Small-Cap ETF SCIF has given up 22 percent while the EGShares India Small-Cap ETF SCIN is over 19.2 percent. The BlackRock Investment Institute offers words of caution and hope regarding Indian equities. Indian "equities could dip by 10% in the next six months if global investor sentiment sours further," according to the paper, but the piece also says investors that can stomach the volatility could see Indian stocks move higher by 10 percent to 15% over the next 18 months. It could easily be investor sentiment that drives the performance of Indian equities over the near- to medium-term. "As the Institute points out, India was a top-five contributor to global growth in 2011 and it has the world's 11th largest economy. As a result, a further faltering India would only add to global investor anxiety and would be a negative for global equities," Koesterich said. For more on India ETFs, click here.