Indian stocks surged 10% last week after a long period of underperformance. Market experts say oil prices must fall to $70-80 per barrel to sustain this rally. Lower energy costs would help control inflation and boost the rupee. Meanwhile, corporate earnings are expected to grow strongly over the coming years.
For the huge market rally to sustain, oil prices must come down to levels of $70-80/bbl
What will sustain their interest and keep the rally going? Much depends on oil prices. A decline to $75-80/barrel would leave India's macroeconomic fundamentals considerably less vulnerable. India has weathered the energy shock remarkably well, and improved oil supplies would strengthen the momentum. Smaller oil and fertiliser import bills would ease pressure on inflation, the trade deficit, and, importantly, the currency. Lower oil prices should also have a salutary effect on other commodity prices, allowing inflation to moderate meaningfully and reducing the need for interest rate increases. Optimism on this front probably propelled the rupee past the 94 mark against the dollar on Friday.
A stable rupee, softer inflation, and lower bond yields could work wonders for equities. Before last week's 10% surge, Indian stocks had underperformed woefully, losing roughly 25% from their September 2024 peak, even as emerging market (EM) indices gained about 50%. Foreign ownership had fallen to a 15-year low as EM fund managers slashed India allocations. At just 10%, India's weight is half its earlier level, while Taiwan, Korea, and China together account for 70% of the EM index. These depressed allocations could soon reverse. With the economy in good shape, corporate profits are recovering strongly. Nifty earnings are projected to grow 18-19% in FY27, following a modest 7-8% in the preceding year. The sharp price correction has also restored valuations to more reasonable levels. At 25,030, the Nifty trades at just under 18 times estimated FY28 earnings and 15 times projected FY29 earnings. More importantly, a sustained revival in foreign buying could help narrow India's performance gap with other emerging markets over the coming months.
Some caveats remain. For growth and consumption demand to sustain, oil prices must fall substantially. Elevated food and energy prices are eroding disposable incomes, while a subnormal monsoon could further dampen demand, particularly in rural India where real wages have declined. Rising costs have also disproportionately hurt smaller businesses. Investment is undoubtedly growing, but neither its scale nor its breadth is sufficient to compensate for a consumption slowdown. Indeed, any signs of weakening demand could push capital expenditure onto the back burner. The recovery in corporate earnings, while encouraging, will also need to translate into sustained revenue growth rather than merely reflecting cost efficiencies. Equally, foreign inflows could prove fickle if the global risk appetite weakens or oil prices rebound. The rally therefore remains vulnerable to external shocks, notwithstanding the improvement in valuations and sentiment. For now, though, the potential rewards outweigh the risks. There may be no need for a capital gains tax cut after all.