India ETFs Plunge on Higher Budget News

Exchange traded funds tracking India, Asia's third-largest economy, are getting crushed Thursday after the government there unveiled surprise spending increases ahead of next year's elections. Indian government expenditures will surge 16 percent for the 2013/14 fiscal year to $309 billion, Reuters reported.

On the heels of a slack fourth-quarter GDP report and with India already dealing with a tenuous grip on its investment-grade credit rating, economists and investors expected more of a commitment to spending cuts from Finance Minister P. Chidambaram, not spending increases.

India's GDP grew at 4.5 percent in the fourth quarter, the slowest pace of growth in almost four years. ETFs are showing an adverse reaction to Chidambaram's spending plans as the WisdomTree India Earnings ETF (NYSE:EPI) is down 3.2 percent today. The PowerShares India Portfolio (NYSE:PIN) is lower by 3.3 percent while the iShares S&P India Nifty 50 Index (NASDAQ:INDY) is off 3.1 percent.

Noteworthy is the fact that Fitch Ratings and Standard & Poor's have said that India's new budget will not prompt a sovereign debt downgrade. The two ratings agency have previously said India's investment-grade rating could be in danger unless the government gets a better hold of its finances. At BBB- on the S&P scale, India's credit rating is the lowest in investment-grade territory and the lowest among the four BRIC nations.

Chidambaram, widely viewed as a possible candidate for prime minister next year, disappointed investors by rolling out a budget that does not deliver a much anticipated cut in withholding taxes for debt investments, Reuters reported.

Last last year, India unveiled a series of reforms aimed at boosting foreign investment, news that helped buoy the late-year fortunes of EPI, PIN and other India ETFs. However, the country also proposed General Anti-Avoidance Regulations (GAAR) earlier in the year, casting a pall over Indian stocks.

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.

However, markets apparently wanted more out of the Chidambaram regarding avenues to increase foreign direct investment.

Increased government spending ahead of national elections is not a new theme. Investors and voters have seen it in the U.S. decades and the emerging world has taken a page from the U.S. playbook. Last year, Malaysia unveiled a massive spending program ahead of this year elections though that has done little to support the iShares MSCI Malaysia ETF in 2013.

Spending is not the only issue. Chidambaram is looking to impose new taxes on large companies to boost revenue rather than reduce spending. That could be a negative catalyst for EPI, PIN and INDY because those ETFs are heavily focused on Indian large-caps.

That said, small-caps ETFs are reacting even more poorly to the news. Already the 2013 laggards of the India ETF lot, the Market Vectors India Small-Cap ETF (NYSE:SCIF) and the EGShares India Small-Cap ETF (NYSE:SCIN) are both lower by more than five percent today.

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