The Chinese method of maintaining export competitiveness is to peg a low Yuan to the USD. By ploughing export earnings back into US treasuries, China also ensures that US interest rates stay low and hence, consumer demand is high.

The problem is, the US is in trouble and the Chinese strategy has led to the People's Republic of China's economy becoming highly-correlated to America. China cannot pull reserves out of US bond markets without causing a crash that may destroy its cash-cow. 

Indian exporters suffer less from similar overdependence on the dollar and US markets. But unlike the pegged Yuan, the rupee has swung wildly in the last 18 months. The short-term direction now depends on two factors.

Appreciation will occur if widening yield differentials post the repo-hike triggers higher inflows despite likely downgrades of Indian debt. It will depreciate if portfolio investors continue to sell in large quantities.

Both factors depend on global risk appetite. Will investors be risk-averse and stay in recessive first world economies where, at the least, currencies are fungible and easily hedged? Or will they grab growth in India despite the risk of investing in a third world economy with a dirty float?

Some smart money will land on both sides of that intellectual fence. There won't be an absolute shutdown. However India needs a lot of money to meet forecasts and targets of the 11th Plan (2007-12). If the investment inflows don't materialise, infrastructure gaps will hinder GDP growth.

In classic cash-flow terms, India is cash-negative. While operations do generate cash, financing outflows are huge due to the consolidated fiscal. In order to have a hope of eventually wiping out the deficit, India needs vast quantities of investment. That money must come from abroad since it isn't available here. If the money doesn't come, plan targets will be revised downward.

Trends, whatever they may be, will take many months, maybe even years to play out. There is little individual businesses can do. Exporters with US over-dependency can seek markets in Europe but those are also low growth. Domestic players will simply have to stick it out until things improve. 

In such an environment, strong, debt-free balance sheets and positive cash-flows are more important than meeting big year-on-year earnings growth targets. Companies that need cash will have to pay high rates for that capital. A conservative strategy of maintaining low gearing and expanding through internal accruals is less dangerous.

Very few Indian companies have strong balance sheets and positive cash-flows at this moment. Credit was cheap for several years and everybody has quite rightly, been in expansion mode. Those investments should eventually pay off.  But as the cost of capital rises and demand slows, that strategy must change.

The lack of candidates with requisite balance-sheet strengths actually makes the task of building a core portfolio easier. It is a very unfashionable style of investment and one that has generated sub-optimal returns for several years. But it could be the way to go during the next phase of the economic cycle.

Chances are, the few growth stocks that do have solid balance sheets and generate positive cash flows will end up top of the heap during the next two years, even if they don't have the highest growth rates at this instant.

Most growth stocks are capital-hungry. This is one reason to be nervous about the telecom sector - it needs huge investments and it may struggle to access funds for a variety of reasons including regulatory issues. Similarly large portions of the financial sector will struggle due to high costs of capital and lower demand for credit.

IT looks quite attractive in this context. IT has underperformed for the past two years as first, the strong rupee and then, weakness in the US has been factored into prices. It is not seen as a growth sector anymore and 2008-09 guidance and projections are anaemic.

But most IT majors have decent balance sheets and low debt. Although their financials show the impact of slowdown, most are cash-rich, not capital-hungry. If they can find alternate markets to cut down the dependence on US, they would be well placed to come out stronger from the bottom of this particular credit cycle.