By Craig Mellow

India's future still looks bright. Its present has gone a bit cloudy. The iShares MSCI India exchange-traded fund has dropped 14% from a peak in late September.

The law of gravity is partly to blame. The ETF climbed by half over the previous 18 months. So is the flight to the dollar and U.S. securities since President Donald Trump's election.

Indian fundamentals are also at play. The central bank has held its key interest rate at 6.5% since early 2023, and Prime Minister Narendra Modi's government dialed back spending since a pre-election splurge early last year. That is showing up in corporate profits.

"Earnings have slowed down a bit from 20% growth annually to midteens," notes James Thom, head of India equity strategy for asset manager abrdn.

Things will get worse before they get better on an index basis, predicts Matt Orton, head of market strategy at Raymond James Investment Management. "India is still my biggest country overweight outside the U.S.," he says. "But the correction needs to get to 20% to be more attractive to foreign investors."

Now could be a good time for stock-picking before the next turnaround, though. Orton is focusing on financials, particularly the two dominant private sector banks, HDFC Bank and ICICI Bank. Both offer "stable return on equity and exposure to the growing wealth management segment."

Banks are "trading below historical averages, and asset quality is holding up," adds Venkat Pasupuleti, portfolio co-manager for India at Dalton Investments. He favors smaller rivals Axis Bank and Kotak Mahindra Bank, whose current prices are "very compelling."

Indian electric vehicles are an infant industry to watch, notes Ajit Dayal, founder of Mumbai-based Quantum Advisors. The government is aiming for 30% of the car market and 80% of two-wheelers to be electric by 2030, which would mean two-thirds annual growth until then. Internal combustion mainstay Tata Motors is leading so far, but Orton favors Mahindra & Mahindra. "They're a more premium group that can keep pricing power," he explains.

Two events loom on India's political calendar. Modi unveils a federal budget Feb. 1, looking to thread the needle between his transformative infrastructure ambitions and rising deficits.

The Reserve Bank of India meets Feb. 6, with new Gov. Sanjay Malhotra balancing a stimulative rate cut against a rupee that has fallen 3% against the dollar over the past four months.

India has room to cut by at least 0.25%, thinks Ning Sun, senior emerging markets strategist at State Street Global Markets. With the consumer price basket anchored by domestically produced food, central bankers need to worry less than peers elsewhere about importing inflation with a weaker currency. They also have more than $600 billion in foreign reserves to smooth the rupee's path.

"With the least volatile currency in EM, they can afford to let depreciation help growth," she says.

Others aren't so sure. "The new RBI governor might want to see how the dust settles in the U.S. before moving," abrdn's Thom predicts. "India's rate path will be dictated by the Fed."

Economic slowdown in India is a relative term. Gross domestic product growth will cool to 7% for the fiscal year ending this March, from 8.3% a year earlier, Moody's predicts. "India is where China was in the early-to-mid 2000s," Raymond James' Orton says.

The market's problem is that valuations outran even this robust expansion. Right sizing is under way.

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

January 24, 2025 03:00 ET (08:00 GMT)

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