Indian stock market has started the year with a bang, earning year-to-date return of 13.9% in local currency terms. If you combine the return from an appreciating currency, the returns for international investors exceed 25% in 2012. The rupee appreciated by almost 8% in January against US dollar, a sharp reversal from being the worst performing Asian currency in 2011. (readTop Three Emerging Market Consumer ETFs)

Indian stocks had a dismal performance in 2011, as the economy grew at its slowest pace since 2009 (resulting from uncertain global environment and cumulative impact of past tightening cycle), and foreign investors withdrew funds for safe haven investments, as the global risk perception deteriorated. Inflation worsened and current account deficit widened. The country’s investment image also took a beating from major corruption scandals and a widening fiscal deficit. (readIndia ETFs: Behind The Crash)

But things seem to have improved in the current year. As the US economy now appears to be on a slow recovery path and Europe’s problems more or less contained, the global investors have returned to invest at attractive valuations resulting from last year’s sell-off. (readThree Overlooked Emerging Market ETFs)

The central bank recently reduced cash reserve ratio of the banks by 50 basis points and while it has acknowledged that cycle of rate increases had peaked, upside risks to inflation remain. Inflation has moderated somewhat in the recent past, mainly due to decline in seasonal food prices. If there is better visibility on inflation and the growth continues to moderate, then we may see a rate cut in the next couple of months. The central bank also recently relaxed the restrictions on foreign investments to woo foreign investors. (read:Go Local With Emerging Market Bond ETFs)

And while the outlook for the market and the current valuations still look attractive, we may add that the Indian stock markets have a high volatility, as their performance depend significantly on the foreign institutional investors. The rupee also remains vulnerable to major capital flows, even though the country has foreign exchange reserves exceeding $300 billion, as the currency market is much less liquid than major currency markets.

We analyze three ETFs that provide broad exposure to the Indian equitiesmarket.

Wisdom Tree India Earning Fund ( EPI - ETF report )

EPI tracks the Wisdom Tree India Earning Index, which weights the Indian companies based on their earnings, adjusted for a factor that takes into account the shares available to the foreign investors. In terms of sector weightings, the fund has highest exposure to financials (24.02%), followed by energy (18.80%), materials (12.64%) and information technology (12.19%). Top 10 holdings account for about 40% of total holdings. Indian banking sector looks stable as of now, as the non-performing assets have declined and the capital levels have improved. A reversal in the monetary cycle will also be good for the banks. Further, with a large percentage of population still unbanked, the banks have significant growth opportunities.

PowerShares India Portfolio ( PIN - ETF report )

PIN which tracks the Indus India Index, has assigned highest weighting to the Energy sector (24.83%), followed by information technology (16.69%) and financials (12.60%). The Indian IT industry faces some near term challenges due to sovereign debt crisis in Europe (resulting in budget delays) and an appreciating currency. Top ten holdings constitute 53.7% of the holdings.

S&P India Nifty 50 Index Fund ( INDY - ETF report )

INDY follows S&P CNX Nifty Index, free float market cap weighted index of 50 largest and most liquid Indian companies. Top 10 companies in the fund account for 56.47% of the fund. Sector weighting are financials (24.57%), Information Technology (13.98%) and Power (13.75%).

iShares MSCI India Index Fund ( INDA - ETF report )

This is the newest ETF in the space, launched last week. The fund follows MSCI India Index, which is float adjusted market cap weighted index. Holdings and sector weighting are not very different from the older three discussed above but with the expense ratio at 0.65%, this is the cheapest option now. Financials enjoy highest weighting (24.87%), followed by information technology (18.85%) and energy (12.22%). Top ten companies account for more than half of the total holdings.