After a Rough Patch, India Garners Bull Calls

It has been a volatile year to say the least for Indian equities and the ETFs tracking those stocks. India-specific ETFs such as the WisdomTree India Earnings ETF (NYSE:EPI) and the EGShares India Small Cap ETF (NYSE:SCIN), just to name a pair, started 2012 with a bang only to wither late in the first quarter.

Amid continued concerns about inflation and Standard & Poor's lowered outlook on India's already tenuous investment-grade credit rating to negative from stable, the withering turned into an all-out plunge that chased investors out of Indian equities and ETFs.

The middle of the second quarter was particularly brutal for India ETFs as funds such as EPI, SCIN, the iShares S&P India Nifty 50 Index Fund (NASDAQ:INDY) and the PowerShares India Portfolio (NYSE:PIN) incurred large drops in share price and, in some cases, alarming declines in assets under management.

Those ETFs and others tracking Asia's third-largest economy have recently rebounded and some analysts are becoming increasingly bullish on India.

Acknowledging "India's economic problems stem from a fractured political coalition, lack of political will, persistent inflation and unreliable infrastructure," WisdomTree Research Director Jeremy Schwartz said in a new research note, "the Indian government took significant steps in mid-September to strengthen the economy and break political stalemates. We believe the latest policy actions have improved sentiment toward India and could benefit the Indian equity market."

Among the policy measures taken by the Indian government are reduced diesel subsidies, looser rules on foreign ownership in India's retail sector and moves taken by the Reserve Bank of India to infuse liquidity into the banking system. The central bank cut its minimum cash requirement by 25 basis points to 4.5 percent.

Should the cash requirement reduction deliver the expected increase in liquidity, it could prove to be a boon for some of the aforementioned ETFs. For example, EPI devotes nearly 28.3 percent of its weight to financials. INDY has an allocation of almost 21 percent to banks while the newly minted iShares MSCI India Index Fund (BATS: INDA) has a weight of over 29 percent to financials.

Despite the positive actions taken by the Indian government, it did propose General Anti-Avoidance Regulations (GAAR) earlier this year, casting a dark cloud over Indian equities, as Schwartz notes.

There has been some talk of deferring GAAR, which could be a near-term positive for Indian equities. GAAR's implementation could be delayed for up to three years so that companies with tax residency in Mauritius are not overly penalized.

"Many U.S. equity funds that provide exposure to India do so through structures incorporated in Mauritius," according to Schwartz. "Among other things, use of these structures allows companies to benefit from the favorable tax treaty between India and Mauritius. We believe the implementation of the expert committee's recommendations could act as a catalyst for investors to regain interest in India's equities and could potentially benefit Indian equity markets. We see the latest recommendations being made with respect to GAAR as a positive catalyst for India's equities."

Another issue to consider regarding is valuation. Following a recent rebalance that altered some of its sector weights, the WisdomTree India Earnings Index, the index tracked by EPI, sported a price-to-earnings ratio 8.75, according to WisdomTree data. That is well below the P/E of 16.64 owned by the iShares MSCI Emerging Markets Index Fund (NYSE:EEM). It also indicates EPI is cheaper on a P/E basis than the iShares MSCI Brazil Index Fund (NYSE:EWZ) and the iShares FTSE China 25 Index Fund (NYSE:FXI).

"In 2012, India's equity markets have performed well compared to the broader MSCI Emerging Markets Index and have provided positive absolute returns so far this year," wrote Schwartz. "The WisdomTree India Earnings Index rebalance has taken effect and reweighted securities with an emphasis on those companies that have grown their earnings over the past year. The rebalance has lowered the Index P/E ratio from 9.26 times earnings to 8.75 times earnings. We believe India's long-term economic growth prospects remain intact and think that the most prudent way to access the Indian equity market is by focusing on companies with strong earnings and fundamentals."

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(c) 2012 Benzinga does not provide investment advice. All rights reserved.