After a relatively stable first half of fiscal year 2013, the Indian markets took a turn for the worse. The economy of the world's largest democracy has been facing severe headwinds in the form of widening current and capital account deficits, diminishing GDP growth, and a lack of investor-friendly policies.
Furthermore, the economy's growth has long been stunted by a failure to implement proactive policies and structural reforms.
New policy actions to the rescue
The central bank of the Indian economy, the Reserve Bank of India, has a new governor in Dr. Raghuram Rajan, who foresaw the 2008-2009 meltdown long before it occurred. Rajan recently announced a slew of policies that could well set in motion the structural reform needed to solve the long-term problems of the Indian economy.
As expected, Indian equities and the rupee registered huge gains on the day of the announcement.
Competitive banking-sector policies
One of the most impressive developments has been the fact that policy aims to make the Indian banking sector more competitive by increasing the external (i.e., international) borrowing capacity of banks.
This will not only help to curb the fall in the currency in the short term, but also help pave the way for accelerated growth, as banks would have access to higher amounts of relatively cheaper funds from overseas markets.
Facilitating increased foreign institutional participation
The policies are also aimed to make India more investor-friendly by relaxing limits on overseas investments on the Indian financial markets. This is vital for a country like India, because the economy is highly dependent on foreign portfolio flows, not only to take equity prices higher and boost the currency, but also to finance the ever-increasing current and capital account deficit.
Two ETFs to play the turnaround
Given the current policies on the table, I am particularly bullish on the small-cap space in Indian equities from current levels. This is primarily because small-cap stocks are considered the true indicator of a nation's economic health. And with the Indian economy set for a revival thanks to the recent policy measures, the small-cap space could see a strong uptrend from here.
Therefore the Market Vectors India Small Cap ETF (SCIF +0.26%), with an asset base of $90.39 million, could be a good option for investor. The ETF has a large allocation toward banks and the financial sector (20%), which is an added advantage, as the Indian financial sector would be the biggest beneficiary of the latest policies.
Further, another bullish argument for the small caps is that unlike their large-cap counterparts, they have not witnessed much buying as yet. This makes them more attractive than the large caps from a valuation perspective. This is the sole reason why the large-cap PowerShares India ETF does not appeal to me as much as its small-cap cousin, the Market Vectors India Small Cap ETF.
Another sector that's sure to get a boost from these policies is the infrastructure sector, as infrastructure development is the backbone of economic growth. This is especially true for the Indian economy, which has to spend a great deal on infrastructure facilities in order to accommodate its ever-growing population.
To play this potential uptrend, investors could look into the EGShares India Infrastructure ETF (INXX +0.00%), which tracks the performance of infrastructure stocks in the Indian equity space. The ETF manages a relatively small asset base of $15.34 million and charges a 0.85% expense ratio.
The following chart shows the one-year comparative performance of these ETFs. Although at first glance the chart looks ordinary, the impressive thing is that these ETFs have recently started showing signs of a recovery:
The bottom line
Finally, before building exposure through these products, you must consider the fact that these ETFs demand a long-term investing horizon, as India's economic turnaround will take a long time to accomplish, especially as the country struggles to make a mark in the global economy due to corruption and intimidating policy bottlenecks. However, with the policy actions at hand, the economy has surely taken a step toward recovery.
