Investors and India: Is a Bollywood Ending Possible?

India has been in the headlines for all the wrong reasons lately - erratic policy, massive power failures and the risk of becoming the first BRIC country to lose its investment grade status.

Mumbai, India skyline.
Marcus Lyon | Getty Images
Mumbai, India skyline.

Growth has also slowedto a nine-year low of 5.3 percent in the March quarter. The Reserve Bank of India (RBI) has cut its forecast for the 2013 fiscal year to 6.5 percent, while many analysts are predicting even weaker growth.

All this has prompted investors to re-evaluate their feelings about India. The most recent evidence of this is the plunge in Foreign Direct Investment in the last quarter. Net inflows into the country over April-June were a paltry $5.6 billion compared to $12.2 billion a year ago, the Times of India reported, quoting RBI data.

But is it wise of investors to ignore about 6 percent growth in an era where many economies are struggling to stay out of recession?

Should you hold out for a “10” when a perfectly good “6.5” is right in front of you?

Some say it’s time to get over the heady rush of 9 percent GDP growth of the past and focus on India’s long-term potential.

A Billion Consumers?

India’s most attractive feature is domestic consumption. With a population of 1.2 billion, it is the second most populous country in the world after China.

Chanda Kochhar, CEO of ICICI Bank, says India’s demographics – with more than 50 percent of the population below the age of 25 - are key to the country’s growth prospects.

“Our basic fundamentals and demographics are still very strong. As we improve our executive decision making and bring a lot of clarity on our economic environment, I think the multiplier effect of getting back to the (9 percent) growth rate, that would be pretty fast,” said Kochhar.

A lot of small businesses produce goods mainly for the local population and are not dependent on exports, hence they are not feeling the impact of a slowdown.

“In India there are so many communities and each one has a different festival and they come one after the other. That's why business is good,” said Mohammed Wasim, who owns a textile shop in Mumbai’s Dharavi slum.

The prevailing view is that no matter what happens globally, local consumerswill provide India’s economy with a protective buffer.

But there are hurdles to overcome before investors can be rewarded with a happy ending.

India’s coalition government is grappling with a gridlocked parliament. With elections not scheduled until 2014, the country’s immediate economic future hinges on the ability of political parties to cooperate and implement economic policies that promote growth.

A New Sense of Urgency

However, some hope the appointment of 66-year-old P Chidambaram for a third term as finance minister will get things moving again.

Dinesh Vaswani, Managing Director of Acuitas Capital does not expect major reforms soon, but says Chidambaram may be able to affect some change.

“There are clearly things the new finance minister can do to change sentiment. One of the things of the self-inflicted wounds came from the introduction of the infamous GAAR (The General Anti-Avoidance Rules). There’s some talk that they are reviewing that and taking a fresh look,” said Vaswani.

The GAAR aims to target tax evaders but lack of clarity and details regarding the rules has had investors worried.

Other industry leaders say they are also seeing positive signs. The CEO of Essar Group, Prashant Ruia says things are finally starting to happen.

“The government is now making a lot of positive signs to sort of kick-start the economy again,” Ruia told CNBC during an interview in Mumbai. “India largely has coal-based power and the policy paralysis delayed most of the approvals required for that coal to be made available. And there’s been a lot of positive movement in that aspect.”

The need for power sector reforms was highlighted by recent power outagesthat left more than half the population without electricity for several hours.

ICICI’s Kochhar agrees there is a palpable sense of urgency in the air.

“I think there is a … clear desire to get decisions moving and I think (we) don’t actually need to wait until 2014. If we get decisions and clarity on tax regime and so on, I think you will see a whole lot of sentiment changing,” she said.

Central bank officials confirm that they too are sensing a shift. The RBI’s Deputy Governor Subir Gokarn says there is now recognition across the board that policy gridlock is at the heart of India’s economic woes.

“We’ve been on the verge (of action) for some time, I think we’ve been starting to perhaps see that, the ability to coast is clearly not there," he told CNBC.

Happily Ever After?

Is investor's love for India about to be reignited?

Jigar Shah, Head of Research at Maybank Kim Eng, is underweight on India but says a genuine shift on the policy front could turn that rating around.

“If the execution is set right in terms of the policies on environment, on mining, on foreign direct investment, I think a lot can get better. It’s probably a good time to look at India again,” said Shah.

Mohit Arora, Executive Director at J.D. Power Asia Pacific says, like marriage, India is an investment for those willing to make a long-term commitment and stick to it.

“I don't think India is for the faint-hearted or the short-sighted. It is clearly for people who are willing to go into that market, make that commitment and be there over the longer term ,” he said.

Follow Lisa Oake on Twitter: @LisaCNBC