MUMBAI (Reuters) - Half a year after India's worst economic crisis since 1991 reduced the rupee to record lows, a government in the last months of its life faces a new moment of truth as emerging markets again show signs of buckling.
This time round countries such as Argentina, Brazil, South Africa and Turkey have been in the firing line.
Investors are less downbeat over India, thanks to actions taken since its mauling by the markets last summer.
"From an FX perspective, a lot of adjustments that had to happen have been made," said Joel Kim, head of Asia Pacific Fixed Income at BlackRock Inc in Singapore. "Particularly, the adjustments in the rupee and balance of payments make us feel a lot more comfortable with exposure in Indian bonds."
Blackrock, the world's biggest fund manager, now calls Indian bonds one of its biggest overweight positions in Asia.
Uncertainty still abounds over India on several scores, however, notably the outcome of a looming election and questions over whether monetary policy will give more priority to stifling inflation rather than bolstering economic growth.
To batten down for the gathering storm in emerging markets and counter inflationary pressures, the Reserve Bank of India raised interest rates by a quarter percentage point on Tuesday, its third such move in five months.
The calibrated response showed a steady hand, and stood in contrast to the dramatic increases in key interest rates announced overnight by Turkey to protect its crumbling lira currency.
India, unlike Turkey, has slashed its current account deficit and built up currency reserves over recent months to protect itself from a repeat of last year's crisis, when the rupee was battered by a global sell-off, as investors fled economies with weak external balances.
Then, as now, the markets turned on expectations of how fast the U.S. Federal Reserve will wind down easy money policies that had helped drag the U.S. economy out of recession and provided money to invest in high-yield emerging markets.
Policymakers say they are confident that India can ride out the latest bout of global volatility, though foreign investors have sold heavily in the last few days. Other countries have suffered far more in the latest shake-out.
Until the global rout struck, overseas investors had been buying India, building positions in equities. January was set to be the second consecutive month of net purchases in bonds.
Since Thursday, when weak manufacturing data in China sparked a stampede out of emerging markets, foreign investors have sold around $1 billion in Indian stocks and bonds, but net bond purchases this month were still around $2.3 billion.
Caution dictated that investors should trim their bets on India. After all, the country faces key hurdles.
There is a general election due by May, that many analysts fear could return a weak coalition government, ill-equipped to lead India out of its slowest period of growth in a decade.
At the same time the central bank is engaged in a high wire act to cool inflation without imperilling weak economic growth.
Still, markets are in better shape than last summer.
Mumbai's share market hit a record closing high last week, and although the rupee fell on Monday to its lowest against the dollar since late November, the currency is nearly 11 percent above a record low of 68.85 to the dollar hit on August 28.
The gains reflect India's efforts to tackle its Achilles' heel - the current account deficit - with unpopular moves to sharply cut gold imports, while providing currency swap concessions that helped banks raise $34 billion from abroad.
With exports improving as well, the deficit is expected to narrow to 2.5 percent of gross domestic product this fiscal year from a record high 4.8 percent the previous year, the central bank said on Tuesday.
India is also pushing to include government bonds in global debt benchmarks, like those of J.P. Morgan, which analysts say could bring in an additional $20-40 billion.
By mid-January foreign exchange reserves had risen to $292 billion from a three-year low of $274.8 billion in early August. Although that is enough to cover only nearly seven months of imports, it comfortably covers 1,440 percent of short-term debt.
"We are much better prepared for any outflow this time," RBI Governor Raghuram Rajan said on Wednesday in a teleconference with analysts. "We have to continue focusing on getting our domestic house in order something the government is focused on, something the RBI is focused on."
Analysts are less certain that the Congress-led government can resist the temptation of populist measures to shore up support from voters ahead of the election.
Party vice president Rahul Gandhi this month demanded a hike in the ceiling on subsidised gas cylinders, while the government is mulling easing its gold import restriction rules.
"We continue to closely watch the current account deficit, inflation and government deficit figures," said Simon Tan, a portfolio manager of fixed income at Nomura Asset Management Singapore. "We are also closely monitoring the elections for risks that the pace of reforms might be stalled or even rolled back."
Political uncertainty is not the only thing gnawing at investors nerves.
A central bank panel last week recommended reducing India's near double-digit consumer inflation to 4 percent, with a plus or minus band of 2 percent - a policy goal which, if adopted, would make it harder to revive growth.
"The twin deficits, the stickiness of inflation, the political risk, and the slowing economy are still the key concerns in investors' minds," said Geoff Lunt, a senior product specialist director in Asian Fixed Income at HSBC Global Asset Management in Hong Kong.
"However, I emphasise that you are very well paid for that as the yields are high and currency is probably the most fundamentally undervalued in the world."
Writing by Rafael Nam; Additional reporting by Rajesh Kumar Singh in NEW DELHI; Editing by Simon Cameron-Moore