Comment | Indian markets have not shied away from a fight

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Shishir Asthana

The strike by the Indian Air Force on terrorist bases in Pakistani territory is of immense significance from a security perspective. First, it shows that acts of terrorism on Indian soil will be met with a swift response; second, it indicates that the IAF can strike deep into Pakistan, with hardly any opposition; and third, since the Indian foreign secretary called it a ‘pre-emptive strike’ on the basis of intelligence that the Jaish-e-Mohammed terrorist group was planning more suicide attacks, the implication is that India need not wait for suicide bombings, but launch pre-emptive strikes to stop them. This is a huge change in our strategy to combat terrorism.

What then should investors do?

The first thing to note is that the markets seemed to take the attacks in their stride. They opened sharply lower on news of Indian Air Force (IAF) strike in Pakistan but by afternoon had recovered most of the losses. Across the border, the Karachi Stock Exchange which opened 2 percent lower but recovered half of its losses by the afternoon.

The market also seems to be getting used to such ‘surgical strikes’. The current response by the Indian markets is in contrast to its reaction on 29th September 2016 when India conducted a surgical strike in Pakistan. The broad indices fell by 2.3 percent on that day, much greater than the 0.5 percent fall post the IAF attack on Pakistan soil.

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Shishir Asthana

Principal Analyst, Research|Moneycontrol

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Though the market has rebounded from its low, the fear factor is still high. India Vix traded almost 11.46 percent higher at 17.12 as compared to the closing of 15.32 on the previous day, indicating more traders are expecting the market to fall.

That may or may not be the case. From where we stand today there can be four possible outcomes.

First, as the market’s reaction suggests, Pakistan may choose not to escalate the matter further. Notice that the Pakistani Army has tried its best to downplay the attacks, alleging they did no damage. For its part, India too has avoided chest thumping and the Foreign Secretary emphasized that no civilians were hurt. If Pakistan does not retaliate, the matter is done and dusted and the markets have nothing to worry about. At best, Pakistan may step up terrorist attacks as they did after the first surgical strike, but this time the constant fear of reprisals will also loom over the terrorists. In that case, the markets do not have much to worry about. Pakistani authorities have said that they will retaliate, but proportionately and at a time and place of their choosing.

The second scenario could be a sharp escalation that leads to a stand-off between the Indian and Pakistan armies. Such a scenario was what happened during Operation Parakram, after the Parliament attack on December 13, 2001, when the two armies built up their positions across the border. This was the time when the market was in a bear grip post the dot-com bubble. Markets reacted negatively to the attack on Parliament but as armies from India and Pakistan started building up position, the market started to consolidate.

The third outcome could be a short localized war as we had seen during the Kargil fighting. Such an event, defence expert say, can happen only after the snow clears from the mountains. The likely period is around May. This will also be the time when India would be conducting its general elections. A controlled and short term war may rattle the markets a bit as was seen during the Kargil war.

During the Kargil war between May and July, 1999 Indian markets saw a small correction in June but they continued to move higher even as the war progressed.

In short, in all these three scenarios, the markets will bounce back. Do not forget that the likely outcome of all these scenarios is a surge of patriotism that will very likely lead to a surge of support for Prime Minister Modi, as he is seen as the architect of India’s more combative policy against terrorism. That will benefit the markets far more in the long-run.

Of course, it is possible that the final outcome could be a full-blown war, which may also escalate into a nuclear war. In that scenario, we have nothing much to worry about since few investors would live to tell the tale.