Domestic indices failed to perform well in dollar terms for the better part of 2018 because of the sharp rupee plunge in a deteriorating macro environment. Things, however, have changed dramatically in the past three months. Oil prices, which rose to over $80 a barrel in the first six months or so of 2018, started trending lower in the latter half of the year.

India has not just outperformed other emerging markets (EMs), it also attracted the highest ETF flows among EM peers in December. This - amid concerns about the strength of the US economy, and an expected slower pace of rate hikes by the US Federal Reserve - has pushed the rupee higher against the dollar, raising market returns for foreign investors. Add to this resilience in the domestic markets of late, and Indian equities look good among EMs. This has been evident in foreign portfolio investment (FPI) buying in the last two months.

At a time when most global markets were in the red, the Sensex delivered a 3 per cent return in the December quarter. The MSCI EM index fell 8 per cent and the MSCI World index fell 14 per cent during the period. Stock markets in Brazil (15 per cent), Indonesia (6 per cent), and the Philippines (5 per cent) were the only three markets that fared better. Note that the returns in India were made even as FPIs sold a massive Rs 29,000-odd crore of domestic equities in October. This was the same month that the rupee started reversing its losses against the dollar. Analysts say if domestic currency stays in the 70-72 range, India, pegged to remain the fastest growing major economy, may keep attracting foreign money.

The results are visible. India attracted the highest ETF flows among EM peers in December, higher than Brazil. But as world markets grapple with the US-China trade war, a global growth slowdown, and uncertainty over the UK, with or without the Brexit deal, India too has its share of concerns. Upside risk to oil prices, and the outcome of the 2019 general elections, will be key. Valuations of Indian equities are also relatively high vis-a-vis EM peers, which analysts say, is not new given India's higher economic growth rate. Besides, the expected recovery in earnings may take care of any such concern.

Odds Against Rupee Drop

The Karvy Stock Broking investment strategy report 2019 says the rupee looks overvalued in terms of Real Effective Exchange Rate, and this has been the case for the last five years. Other EM currencies have depreciated more against the dollar during the same period. It said that except for scenarios like a significant rally in oil prices, there are few reasons why the rupee should perform poorly against the dollar.

Tarun Satsangi, the founder and CEO of tarunsatsangi.com, expects the dollar index to fall from here on. "If the index extends its slide to 92 and remains in the 92-98 zone, the rupee may get the largest benefit," he says. He expects the rupee to remain in the 69.30-71.50 range for some time. The dollar index compares the movement of the greenback against a basket of six major world currencies. It has a negative correlation with risk asset classes such as equities. Edelweiss Securities sees the rupee around 72 in FY20.

Meanwhile, the Union Cabinet recently approved a proposal for a $75-billion bilateral swap arrangement between India and Japan. The move will enhance the RBI's ability to manage exchange rate volatility, as an agreed amount of capital will be available on tap to meet any short-term deficiency in foreign exchange.

India a Preferred EM Play

Some EMs, including India, are much better positioned when it comes to domestic fundamentals and local corporate profit growth, says HSBC Global Asset Management CIO Tushar Pradhan.

"Brazil, Indonesia and the Philippines have shown robust earnings growth last year but are vulnerable to trade flows and commodity prices. India and Asia (ex-Japan) appear to be favoured picks due to favourable macros (read low inflation and stable interest rates), lower current account deficit (CAD) and less dependence on trade flows," says Pradhan.

Data from an Edelweiss Finance report shows emerging market ETFs have started seeing fresh unit creations. The MSCI ACWI ETF infused $2.16 billion into EMs in December; Vanguard FTSE Emerging Market saw $555 million in unit creation. I-share Core MSCI EM ETF witnessed $1.38 billion flows. This ETF had seen no major fresh unit creation between May and November 2018.

India has been the top beneficiary of such a trend, garnering the highest ETF flows - $2.23 billion during the month - suggests the Edelweiss report. China, in stark contrast, saw the highest outflow of $5.31 billion during the period.

"We should be cognisant of the fact that the quest for growth - the US rate tightening has derailed growth in EMs - could propel EMs to embark on some sort of monetary easing. Trickling inflows in these EM ETFs may well be a sign of things to come in CY19," says the Edelweiss report.

Unfazed by Valuation

Although FIIs in 2018 were net sellers of Indian equities for the first time since 2011 (Rs 33,014 crore), the institutional category turned a net buyer in the past two months. FIIs bought equities worth Rs 2,300 crore in December and Rs 6,223 crore in November.

FPIs may have sold nearly $4 billion in CY18 but the trend should reverse in CY19 if the US Fed takes a softer stance on interest rates, and the RBI does the same, says the head of quantitative research, Edelweiss Securities, Yogesh Radke. "Post-general elections, FPIs will return with more confidence, which should take the market to new highs."

V.K. Vijayakumar, Chief Investment Strategist at Geojit Financial Services, believes FII inflows would continue in EMs, especially India, even if the country is at present trading at a premium against its EM peers.

India's one-year forward PE is around 17. "This is a 60 per cent premium to MSCI EM valuations and, therefore, is very much on the higher side. But this need not be a dampener for FII inflows since India is on the cusp of a sustained earnings recovery," says Vijayakumar.

A Karvy Stock Broking report says India remains one of the few markets where growth is likely to hold up in 2019, making it more attractive.

Oil prices played a crucial role in the domestic macro position by influencing Indias fiscal situation. Data shows Brent prices have corrected 38 per cent from October highs on weakening global economic growth and US-China trade dispute. While there are chances that OPEC, the cartel of oil producers, may go in for production cuts, it may not prove enough to shore up crude prices as long as world economic growth stays tepid.

"With lower crude oil price, oil importing nations will be high on a preferred list of global investors. Of the oil importers, India will be among the preferred destinations for global investors owing to our large domestic economy. The global crude oil price is the single biggest factor that can determine India's macro stability, corporate earnings robustness, rupee strength and hence the overall health of the Indian economy," the brokerage Centrum Wealth said in its strategy note 2019.

Earnings Recovery to be Key

Earnings revival is seen as one of the significant drivers of equity markets with corporate banks expected to post strong numbers on a low base. The December quarter has already shown some signs of revival in earnings with H1FY19 net profit of the Nifty-50 Index growing 12 per cent.

Bank credit growth at 15.1 per cent year-on-year, hitting a five-year high in December quarter, is another indicator that an earnings recovery is well on track.

"We see earnings revival, which has started in FY19 and should accelerate in FY20, to be the most important driver of Indian equity markets in CY19. We believe domestic markets are better placed in comparison to their global counterparts. The gap between earnings yield and bond yield has also narrowed post the recent decline in bond yields," says Kotak Institutional Equities in a research note.

The brokerage expects Nifty50 to post 14 per cent and 27 per cent growth in the net profits for FY19 and FY20. That said, India looks set to outperform EM peers in 2019, offering decent equity returns to both foreign and domestic investors.

@apri_sharma