Geo-political tensions, war and our stock markets

Vikas SinghaniaTrade Smart OnlineThe surgical strike by Indian military on Pakistan soil took everyone by surprise. The news was announced while the market was open. As the Indian Army personnel announced the details of the surgical strike, investors panicked and started selling in the market. Indian markets closed nearly 1.6 per cent lower, but on an intraday basis lost nearly 3 per cent from their highs on the announcement. However, markets have rebounded since then and trade close to the levels where they were before the strike. But this has done little to the apprehension in the mind of a retail investor who feels that the situation could escalate anytime and lead to a larger engagement. Their rationale for the fear is a long and prolonged engagement with the enemy is bad for the economy. This makes logical sense as the government will be forced to divert the limited resource to the defence forces rather than using it for asset creation. Before checking on what history tells us about war and its impact on the economy and markets, we need to understand what actually happens in war. When two countries are at war with each other, attention of the government and public is diverted towards the war effort. Countries have a defence budget, but these are mainly to keep the men and machinery fighting fit. Arsenals are built up and occasionally tested but rarely used. But when it is at war these arsenal and machines are consumed and need to be replenished fast. The defence expenditure has now become expense with the meter running really fast. As a result economic activity in the defense sector picks up. Resources meant for other sector gets utilised by the government. In order to meet the fund requirement, government either approaches the market are prints money, thereby inducing inflation. As far as the economic data print is concerned, the country then records higher GDP, though its constituents might be dominated by fewer sectors only. Higher GDP, a sign of growth, is taken positively by investors. An important point to note during war is that market and economic activity is not disturbed by short wars and skirmishes. Also, if the country by and large is not affected by the war with cities not getting bombed, markets take the event in their strides. A short war has limited impact on the markets as resources diverted for war efforts are limited. Take the example of the two World Wars. While European countries were devastated by the wars, USA which lent support to the war effort by sending its men and machines was largely unaffected. Thus American markets reacted positively after a short dip to the war while the European ones were mostly closed. Documented records show that in 14 shocks dating back to the Pearl Harbour in December 1941, the market reacted the most on the day of the event. The median one-day decline has been 2.4 per cent. Selling on an average lasted for eight days with total losses of 7.4 per cent. The data includes the Korean War, Vietnam war, September 11 attack and the Cuban missile crisis. In all the cases markets recouped the losses within 14 days. As far as Indian markets are concerned, since the time BSE index has been constructed – in 1979 the country has not seen a full blown war. The closest it has come to a war was on the Kargil issue. The first intrusion of report from Pakistan was reported on May 3, 1999 during the localised Kargil war. Indian army backed by the government launched an aggressive retaliation to evacuate Pakistani army. By July 14, 1999 Indian army had officially reclaimed all land prompting the then Prime Minister Atal Bihari Vajpayee to officially declare that the operation was successful. On May 3, 1999 BSE Sensex closed the day at 3378.4. Market on this day had no idea about the intrusion. But by July 14, 1999 it closed at 4,710.25 a gain of 39 per cent, which also was the year’s high level. There was barely any noticeable correction during this period. While a single event is too small to extrapolate future events, the present events in Jammu and Kashmir also seem to be restricted to a small location. Pakistan does not have the economic strength to engage with India on a full scale war. In his epic book Ascent of Money Niall Ferguson highlights the issuance of bonds by governments to raise money to fund war requirements. Bond yields generally rise when government reaches deep for raising capital. Indian bond markets is trading near its six year low level, indicating market does not believe that the present war will impact the country’s financials in anyway.