5 Reasons To Underweight India

Includes: EWT, MCHI
by: Russ Koesterich, CFA

While I generally like emerging markets better than developed ones, one emerging market I’m not a fan of right now is India. As I explained in a recent post, 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.

A new paper from the BlackRock Investment Institute, “When the Elephant Gets Sick: India at a Crossroads,” elaborates on these downsides of the Indian economy and offers a few more. Here’s the paper’s list of five things currently wrong with the Indian economy.

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.

In light of these economic problems, the Institute, like me, expects the Indian market to trade down in the near term. As the paper points out, Indian “equities could dip by 10% in the next six months if global investor sentiment sours further.”

While the Institute also sees the Indian market as a potential long-term opportunity, noting that investors able to handle volatility could see a 10% to 15% upswing over the next 18 months, I’d remain cautious on the market for the next year or so and use it to balance overweights to China (NYSEARCA:MCHI) and Taiwan (NYSEARCA:EWT). In fact, this position has worked well since I started advocating it in February.

And perhaps more importantly, the problems with the Indian economy highlighted above don’t just matter for the Indian market. Just as China’s economic fate is important for the global economy, so too is India’s. 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.

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