I think to a certain extent this is what is currently happening to India as well. If we go back to the beginning of this year, India was a growth market and valued as such with PE multiples in excess of 20. India had delivered four years of 9 per cent plus GDP growth and consistently surprised positively on earnings.

Investors felt that India was insulated from the credit crisis and would maintain its strong GDP and earnings trajectory. The market was over-owned and clearly trading like a growth stock with investors only looking for growth irrespective of capital efficiency. When you have growth-type valuations it is critical that you continue surpassing expectations and surprising positively to maintain the hype.

With the oil price spike, India's macro vulnerabilities were exposed and for the first time both GDP and earnings growth rates were revised downwards and confidence shaken. Investors began to question if India can really grow for a decade at 8 per cent. The weak policy response of a constrained coalition also sowed doubts on India's ability to handle these macro stresses.

Is 8 per cent really the trend growth rate? Are corporate earnings too high and margins bound to compress? If we do not reform, how can we sustain growth? How can any coalition find the stomach to take on vested interests? With such a weak fiscal how will infrastructure ever get fixed? These are some of the issues on investors' minds today.

Like a growth stock which begins to derate once its growth comes into doubt, India is also going through an inevitable derating process as investors no longer take 9 per cent GDP and 25 per cent earnings growth for granted. The general reduction in global risk appetite has also forced this re-assessment.

The problem for India right now is that the market is stuck in a kind of no man's land. It doesn't (at least in the short term) have the growth to justify a PE multiple of 18-20, but trading at about 15 times March 2009 earnings, neither is it cheap enough to attract the value buyers.

One of three things is likely to happen going forward.

First, the market may just fall by another 15-20 per cent, in which case value buyers may get a lot more interested. India at 12.5 times earnings with its quality of companies will attract many buyers. I know that historically India has traded cheaper at even 10.5-11 times and with 10-year bond yields likely to cross double digits, one can argue as to what is cheap.

To my mind given the growing size of the domestic money managers, the quantum of money on the sidelines with private equity players and the continued FDI interest in the country, it is unlikely the market will sustainably drop below these levels. India is also a lot more mainstream today than it was even five years ago, and too large to get ignored like what has happened to a Thailand or a Philippines.

The growth potential of the country is too huge and companies are too smart for investors to give up. Even under the most dire of scenarios, India in the long haul will grow its GDP at 7 per cent plus and earnings at 15-18 per cent, for this growth stream to trade at 10 times implies huge and sustained risk aversion. Possible but unlikely in my view.

A second scenario is the markets just treading water and drifting along at these price levels for another 6-12 months. This ultimately achieves the same thing as bringing valuation levels down to 12.5 times, but we get to these levels through earnings being given time to catch up as opposed to stock prices falling immediately. This will be painful in terms of trading volumes shrinking, volatility dropping and a general sense of inertia pervading the capital markets.

Many investors may prefer to have one large climatic sell-off as in scenario one, rather than the drip by drip Chinese water torture type of market movement implied by scenario two.

A third alternative would be that India regains its growth lustre. The only way that this can happen is for investors to see action on the ground from the government. We need to see movement on second-generation reform, whether it be infrastructure, education, financial system, targeting subsidies, etc.

The current government has been able to do precious little on reform till date, now is its chance. If investors begin to feel that India is once again on the move, and is tackling structural bottlenecks, they will be willing to look through the current cyclical slowdown. The world currently lacks growth engines and if investors start believing once again in the 8 per cent trend growth for India, a lot of money will rush in. Investors have to feel confident that the current growth slowdown is only a cyclical blip in the structural growth dynamic.

The current government seems to have a window of opportunity in front of it; finally rid of the Left can they show their true reformist colours?

Whichever way one cuts it, the next six months is a good time to do the work and build a long-term portfolio in India. Reform can only accelerate compared to the pace of the last four years, and I for one still believe in the 8 per cent trend rate of growth. The markets will most probably give you an opportunity over the coming months to slowly and systematically build a quality portfolio at reasonable prices.

2009 will be a very interesting year, with a new refreshed coalition in its first year, facing severe fiscal headwind, and chances of serious reform are bright. The inflation headwind will also be significantly less and we will see a reversal of the monetary policy environment. Corporate India will also have tightened its belt and we could start seeing earnings surprises again towards the second half of the year.

In such a scenario investors are more likely to once again focus on India's growth potential as opposed to its macro weaknesses.