ETF Insights: India, Indonesia, Italy

India: Slower Growth and Record Inflation Rattle ETFs

India's exchange-traded funds are proving volatile in a climate slowing growth, escalating government spending, and record inflation. After a sharp slide, India ETFs started to turn upward after its ruling coalition narrowly survived a test of leadership regarding the nuclear pact with the US but since then have demonstrated no clear trend.

James Fontanella-Khan of the Financial Times reports that India’s economy grew at it slowest rate in three years, as it struggles to control record-breaking high inflation and tighter credit and lower liquidity. Annual growth slowed to 7.9% in the first fiscal quarter of 2008 ended on June 30, significantly lower than the 8.8% rate reported in March.

India’s central bank recently sent its strongest signal yet that it will not tolerate high inflation, now running at nearly 12%, a 13-year-high, by announcing a larger than expected increase in its key lending rate with more hikes to come. India’s economic growth is being hampered by domestic supply-side constraints, particularly in infrastructure such as power, irrigation and transportation.

India’s agricultural output will also grow just 2%, down from a 4.5% expansion last year, due in part to an erratic monsoon, highlighting the challenge India faces in boosting agricultural productivity and meeting rising demand for food grains.

Industrial output is forecast to grow 7.5%, down from 8.5%, with industry still facing constraints from power shortages, while the service sector is projected to grow 9.6%, down from 10.8% last year. The Indian cabinet has approved an average 21% pay rise for 5 million federal employees and military personnel, the first revision of government salary scales for 12 years. Mr. P. Chidambaram, finance minister, estimates that the civil servants’ pay rise will cost Indian taxpayers $3.6bn this fiscal year.

The ETFs tracking India's market:

iPath MSCI India ETN (INP): down 41% year-to-date
PowerShares India (PIN): down 20.5% since March 5th opening
WisdomTree India Earnings (EPI): down 25.9% since Feb. 26th launch

Indonesia Growth Led by Consumers and Exports

Indonesia’s economy grew a higher-than-expected 6.4% year-on-year in the second quarter of this year, thanks to high commodity prices, strong consumer spending and robust exports. Oddly, consumer confidence fell to its lowest level in three years, on the back of a 30% fuel price increase in May and rising inflation.

This is good news for the Indonesian Fund (IF). This solid growth will give a boost to President Susilo Bambang Yudhoyono as he released the government’s 2009 budget calling for a 55% increase in funds for poverty fighting and a significant expansion of the education budget.

Economic growth in Indonesia, which is southeast Asia’s largest economy and the world’s fourth most populous country, reached 6.3% last year.

Nick Cashmore, of CLSA brokerage in Jakarta, believes that Indonesia had been “exceptionally lucky” because of high prices for coal and other commodities. “If this rising investment cycle picks up, [Indonesia] has the potential for insular growth that will set it apart from its neighbours,” he said. Exports accounted for 30% of growth in the second quarter, far lower than in neighboring countries, while consumer spending represented 60.3%.

Sri Mulyani Indrawati, Indonesia’s chief economics minister, was upbeat. “The growth momentum is very strong and the upward trend on employment and poverty reduction is healthy,” she told the Financial Times. “The main worry is inflation. It will be a couple of months before the central bank and we get it down to single digits again.”

This would be a great story except that market valuations are still high with the stock market trading at 3.5 times book value, 12.2 times cash flow and eighteen times annualized earnings based on S&P data.

Indonesia has been urged by the OECD to overhaul its rigid labor laws, remove foreign investment and ownership restrictions and cut its fuel price subsidies. Despite a 30% increase in fuel prices in May, the Indonesian government is expected to spend one-fifth of its government budget on fuel subsidies this year.

Italy Fights Inflation, Spending and Crime

The new center-right government of Italy is taking action on the fronts of inflation, spending and crime. Chartwell today added the iShares MSCI Italy exchange-traded fund (EWI) to its Country Rotation ETFfolio based on valuations and the pace of market economic reforms.

The Italian government is concerned that spiraling food prices and a six–year high in its core inflation rate will choke consumer confidence. The government plans to include measures in its budget plan for next year to curb the rising cost of basic food products, Prime Minister Silvio Berlusconi said at a news conference in Rome yesterday.

Italy’s parliament last week approved the center-right government’s plans to make substantial cuts in public spending over the next three years to meet European Union requirements to balance the budget by 2011. The measures, involving close to $18bn in cuts, reflect a significant shift in the policies of Silvio Berlusconi, the prime minister, and Giulio Tremonti, the finance minister, whose previous administration, from 2001-06, was characterized by rising spending.

Another key issue in Italy is rising urban crime, and recently Italian troops, some in body armour and with automatic weapons, were deployed on urban crime patrols, fulfilling an election campaign promise by Silvio Berlusconi to make Italy’s cities safer.