India Infrastructure ETF In A Pickle, What’s Next?

by on January 16, 2011 | ETFs Mentioned:

Investors seeking high growth for their portfolios have long grown tired of the meager returns that many U.S.-based investments have offered. As a result many have turned their attention to emerging markets which are nations around the globe with surging populations that are experiencing rapid development. The high growth potential offered in many of these locales caught the eye of investors, and as ETFs have continued to expand their lineups to cater to numerous emerging markets, investors can now reach markets that would otherwise be very difficult to buy into, at least for average investors. One of the top emerging markets in the world is India, which is home to the second largest population on the globe (approximately 1.1 billion) and one of the fastest growth rates for a major country. But with such a large population in a relatively small area, numerous obstacles present themselves as India tries to break into the world of developed nations. One of the biggest issues the country is currently facing is a low quality infrastructure system which threatens to hamper the nation’s development for decades to come [see also Emerging Market ETFs: Seven Factors Every Investor Should Consider].

The figures are astounding: by 2030, India will add 215 million city dwellers, creating 68 cities with populations over one million. But these growing numbers are met with poor quality transit and sanitation systems thanks to sub-optimal funding. According to a recent report, New York spends close to $300 per city dweller on services and infrastructure, while India spends just $17 in comparison. To keep up with the current urbanization, it is estimated that India will need to spend roughly $250 per city dweller, a 15-fold increase in current spending. To meet the demand of the growing population and keep the economy humming along at an impressive clip, Prime Minister Manmohan Singh has developed a plan which could help save the economy from this impending infrastructure crisis [see Three ETFs To Play The Coming Emerging Market Infrastructure Boom].

According to Prime Minister Singh, “infrastructure is the biggest bottleneck to faster economic growth”. To face this bottleneck head on, the country plans to dramatically increase spending to increase the infrastructure expansion rate from 7.4% (2009) to 10% for this year. In the five years ending March 2012, the nation will have spent $500 billion, and Singh intends to extend that figure to $1 trillion for the following five years.

This will represent much needed investment in infrastructure for the nation since, according to the IMF, India is currently ranked 91st out of 139 nations in quality of infrastructure. This puts the country behind even Ethiopia and Indonesia, two countries who have hefty infrastructure issues of their own, but do not have the severe population density problems that India has. In order to raise the massive amounts of capital necessary to alleviate this growing problem, Singh plans to use private financing, as the government lifted the cap on foreign investment in bonds for the first time in 18 months late last year, allowing investors to significantly increase their holdings in Indian debt, hopefully spurring rapid development of the Indian infrastructure system [see also Three ETFs George Soros Might Like].

While this plan may seem solid from the outside, a closer look reveals a major snag in India’s intentions to ramp up its infrastructure. The construction industry is the largest employer behind agriculture in India, and it is estimated that the industry will employ 83 million by 2022. Though the nation has a large number of workers available, the vast majority are unskilled laborers, making it much more difficult to complete major projects. “Lack of skilled workers impacts on all three fronts: quality, delivery and costs” said K.V. Rangaswami, president of Larsen construction company. Rangaswami also went on to say that a skilled labor shortage will be a major economic setback if it the issue is not quickly solved.

In an effort to educate workers, numerous construction companies have set up training schools in India, allowing workers to become specialized in certain trades, benefiting construction companies who are in desperate need of skilled workers. While this is a good first step, there are not enough schools to handle the massive population that India holds. The problem is especially prominent among the youth of the nation, as “53% of unemployed youth suffer from some degree of skill deprivation” says a report from the Confederation of Indian Industry. So while the nation will be significantly increasing its funding in the sector, it still has major labor-based issues to solve before it can efficiently proceed [see also Corruption Scandal Sinks India ETFs].

ETF to watch-INXX

Due to this situation of incredible need and limited skilled-labor supply, investors should keep an eye on the India Infrastructure ETF (INXX) from Emerging Global Advisors. This ETF tracks the Indxx India Infrastructure Index, which is a free-float market capitalization weighted stock market index comprised of 30 leading companies that Indxx, LLC determines to be representative of India’s Infrastructure industries, as defined by the Industry Classification Benchmark (ICB). From a sector standpoint, this ETF pinpoints three in particular: industrial materials (47%), utilities (25.6%), and telecom (12.4%). Although the fund is relatively new it got off to a promising start, but has since suffered, yielding -1.9% since inception in August of last year.

This ETF will be a good one to watch over the long term, as an increase in infrastructure for India is inevitable. Though the country might currently be struggling, with such a largely urbanizing population it will be forced to upgrade in order to simply keep up with its citizens and their exodus to cities. However, with a relatively unskilled population and the lack of infrastructure reaching near crisis proportions, it remains to be seen if India can develop quickly enough to stave off an infrastructure-induced collapse.

The only question that remains is how soon will the nation be able to efficiently upgrade their current systems, and whether or not it translate into strong gains for INXX. So while Indian infrastructure clearly has clearly the greatest need of the major markets, it is also one of the biggest risks to investor portfolios, so caution is advised when considering this high risk, high reward sector. The extremely precarious situation in India could go either way at this point but no matter how it plays out, look for INXX to serve as a quality barometer for the Indian infrastructure market going forward [see all the ETFs that track the infrastructure sector].

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Disclosure: Photo courtesy of Deepak Gupta. No positions at time of writing.