D-STREET MESSAGE: DE-ESCALATE
Markets will have reason to worry if the current situation worsens
AMumbai-based macro economist, on a tour across the global financial centres of Asia, has had to modify his advice to investors every day since February 25. The day began with an assessment of the economic blowback from a retaliation by the Indian side to the Pulwama terror attack. On February 26, the world woke up to the news of air strikes by India, destroying the Jaish-e-Mohammed training camp in Balakot, Pakistan. With the government packaging it as a “non-military, pre-emptive action”, the economist reasoned that the conflict wouldn’t escalate. On February 27, as news of Pakistan’s tit-for-tat strike against India beamed across television channels, he was worried.
A lot has changed since the last time India witnessed such an escalation in 2001, after the attack on the Indian Parliament. During the 1999 Kargil War, India had no foreign investment to speak of. India’s integration with the global economy is much greater now. In 2019, most Indian start-ups are funded by foreign investors. India’s foreign exchange reserves stood at $393 billion in December 2018, close to a historic high, though the foreign direct investment (FDI) declined by 7 per cent year-on-year to $33.5 billion. Prof. N.L. Bhanumurthy of the National Institute of Public Finance and Policy observes, “If I were an investor, I would think of avoiding these muddy waters until May (when the general elections are due).”
India faced sanctions after the Pokhran II tests in 1998. But, in 2019, the growing protectionism around the world presents unique challenges.
“Foreign investors need peace. Since we have liberalised, there have been multiple terrorist attacks. If the current situation results in escalation, there will be concerns. But no two nuclear nations have gone to war, and Pakistan does not have too many supporters. For markets, the bigger risk is the stability of the government. Predictability of policy is important,” says Nilesh Shah, managing director of Kotak Mahindra Asset Management Company Limited.
The equity markets’ response to surgical strikes 2.0 was sharp on February 26, though they recovered later in the day. On February 27, the BSE Sensex gave up early gains and was down 600 points at one stage in a volatile trading day. It ended the day at 35,905—68 points or 0.19 per cent lower than the previous close. Nifty closed 0.26 per cent lower.
“While this is a negative short term, in the long term, there is a positive—it reduces political uncertainty,” says another economist.
The Indian economy took off after the Kargil conflict. “Usually, an exaggerated conflict or short-term wars lead to a demand stimulus in the economy; not just expenditure, the demand also increases. FII and FDI will be postponed. There may be a slippage in fiscal deficit,” explains D.K. Srivastava of EY India.
India has revoked the most favoured nation status accorded to Pakistan in 1996. Pakistan, however, had refused to grant reciprocal status to India. Islamabad has 1,209 items on its negative list, meaning it does not allow imports of these items from India. Experts believe that revoking the status will not have much impact on Pakistan, as India’s exports to that country are much higher than what it imports from Pakistan. India imported goods worth $488.5 million (Rs 3,468 crore) in 2017-18 and exported goods worth $1.92 billion (Rs 13,632 crore) in that fiscal. Trade between India and Pakistan rose marginally to $2.41 billion (Rs 17,111 crore) in 2017-18 as against $2.27 billion (Rs 16,117 crore) in 2016-17.
Any escalation of tension between the two countries will have a much worse impact on Pakistan’s economy, since it was hoping for a revival under prime minister Imran Khan.
“Once the Pakistan economy did better, there would have been a big market next door,” says Biswajit Dhar of the Centre for Economic Studies and Planning, Jawaharlal Nehru University. That opportunity is in jeopardy now.
India in all but one of its wars, from 1947-48 to 1965 and 1999. It used suicide attackers affiliated to the Haqqani network to target Indian interests in Afghanistan between 2008 and 2010. In the most brazen attack, a suicide bomber attacked the Indian embassy in Kabul killing 58 people, including the military attache.
One of the pillars of hybrid warfare is the use of what are variously called non-state actors, guerrillas, terrorist proxies or irregulars to fight conventional armies. India has used this option against Pakistan just once, during the 1971 war when it trained close to 100,000 East Pakistani nationals, the ‘Mukti Bahini’ that tied down the Pakistan army garrison. Using the covert option to retaliate is complicated because, as analysts say, it takes several years to raise such capabilities and sustain them. It is hence not an option that is on the table.
AIR ACTION (Escalate to level 5) Probability of further use: Low
The death of 40 CRPF troopers in an attack by a suicide bomber on February 14 in Pulwama put tremendous pressure on the Narendra Modi government to act. Particularly since the government is in election mode. The options for a ground assault using special forces or the regular army were severely restricted because most of the LoC was snowbound. Air strikes using the air force were seen as the preferred mode of delivering ordnance on the targets selected by Indian intelligence agencies. The use of air power in the attack was hugely escalatory as it gave the strike high visibility and added a new dimension to Indian retaliation. Further air strikes could, however, dramatically escalate the conflict since both sides are capable of striking at each other. Even now, with the retaliatory air strikes by Pakistan, the government is under more pressure to respond and top up its escalatory dynamic. The utility of this move could prove limiting as India presently lacks overwhelming air superiority over the PAF of the kind Israel enjoys over all its neighbours, for example.
“We can keep doing this one-off air strike thing with Pakistan. We can send in a batch of 20 aircraft, but Pakistan can do the same with a smaller number of aircraft and hit you,” says a senior defence official.
DE-ESCALATION (Back to level 1 on the escalation ladder) Probability: High
Analysts say this is an extremely likely next course of action. Imran Khan signalled this hours after the PAF jets intruded into the LoC. “The counter-response to the Pakistani provocation lies in the Indian domain but it is unlikely that India will calibrate this any higher,” says Lt Gen. Syed Ata Hasnain (retd), former 15 Corps Commander. “With Pakistan effectively isolated and the international community firmly with India, this may be the time for us to de-escalate. However, the release of the Indian pilot is now a major priority. The narrative will once again move into the diplomatic domain.”
“Pakistan has tried to retaliate through non-military means and attempted a face-saver by going up the escalatory ladder. Both sides need to understand that any more escalation could be dangerous and stand down,” says Air Marshal S.R.K. Nair (retd).
FURTHER AIR STRIKES COULD DRAMATICALLY ESCALATE THE CONFLICT AS BOTH SIDES ARE WELL-MATCHED