Air Strike

Indian Air Force (IAF) on Tuesday carried out pre-dawn air strikes on
terror camps across the Line of Control (LoC) in the Pakistani side, 12 days
after Pulwama terrorist attack in Kashmir. The attacks reflect India's firm
determination to weed out terrorism. While the initial response of the
financial market was negative, a market research believes such attacks are
unlikely to have any material impact on the markets.
Indian economy is currently on a sound footing with favourable macro
numbers. To substantiate their argument, the report analysed two such past
events and their financial impact.
For example, the Kargil war was fought between India and Pakistan in
Kargil during May to July 1999. During the aforesaid period, the leading
indices of Indian stock markets showed an initial decline but strong
recovery thereafter. The Sensex and Nifty declined by 286 points and 79
points, respectively, in initial three days of trading, but recovered strongly
thereafter and ended higher by 652 points and 191 points when the conflict
ended. The overall impact of the Kargil war was in fact positive for the
markets. The economy grew at the same pace in 1999-2000 as the year
before - a healthy 6.5 per cent.
In the
similar
vein, post
Uri surgical
strikes,
Indian
financial
markets
gained with
the Sensex
climbing by more than 100 points and the rupee too appreciated. From a
longer perspective, Indian financial markets, including the stock, currency,
and even the bond market showed traction. For example, stock markets
jumped by 3,456 points, while the rupee appreciated by 2.4 per cent.
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Pakistan's current account deficit (CAD) is forecast to be 5 per cent
for 2019. The country's foreign currency reserves have reportedly
dwindled to around $8 billion, just enough to cover about two
months of imports. To avoid a balance of payments crisis, Pakistan
previously reached out to Saudi Arabia and China. It is currently in
talks with the International Monetary Fund (IMF) for a second
bailout in five years. India's recent decision to raise the customs
duty on all goods imported from Pakistan to 200 per cent, including
fresh fruits and cement, may add to the woes.

Various risk indicators, too, have reported limited impact. India VIX (Volatility Index)—
fear gauge indicator for Indian equities — rose by 11 per cent to 17.12 in a reaction
to the airstrike. The current reading to the India VIX is just 4.3 per cent higher than
average VIX in the past five years. In addition, the yield premium due on 2024 dollar
bonds floated by State Bank of India, which is a proxy of sovereign rating of India,
remained largely unchanged at 101.6 basis points on Tuesday, according to
Bloomberg. The implied volatility for the next three months for Rupee dropped 18
basis points to 8.7 per cent.

“War will be a difficult option with both countries sitting on nuclear

weapons. There can be escalation of conflict, but it is unlikely to
turn into a full-fledged war. Logically it should die down in
sometime, “said G Chokkalingam, managing director of
Equinomics Research. “There could be other risks to the market,
but a risk of war is improbable.”

“The reason why you are not seeing such a negative sentiment in India is
simply because rest of the emerging markets are doing fairly well, oil is
lower and yields are lower,” said Ashish Vaidya, head of trading at DBS
Bank Ltd. in Mumbai. “That’s providing support to the rupee.” The outlook
for emerging-market stocks has improved, thanks to growing optimism that
the U.S. and China will resolve their trade dispute and the dollar could
weaken as the Federal Reserve pauses its rate hiking program. Prices of
oil -- India’s top import -- extended losses Tuesday after tumbling the most
in four weeks after Donald Trump’s criticism that prices are too high.

Foreign Secretary Vijay Gokhale said in New Delhi today that India carried
out strikes in Pakistan following an attack in Kashmir this month in
response to intelligence that indicated Jaish-e-Mohammed was planning
more. The biggest Jaish-e-Mohammed training camp in Balakot was
destroyed, Gokhale said. Over 300 terrorists were killed in the air strike, an
unnamed Indian official said.
His statement has been “carefully worded to convey that the target was
only the terror camps and there haven’t been any civilian casualty,” said A.
K. Prabhakar, head of research at IDBI Capital Market Services Ltd.
“Stocks may stay volatile for a couple of days as investors watch on how
the other side responds to this action.”

Tuesday’s strikes won’t materially impact markets, State Bank of India’s

chief economic adviser Soumya Kanti Ghosh wrote in a note, citing
previous conflicts of Kargil in 1999 and Uri in 2016. “These strikes act as a
positive deterrent for the markets for the decisiveness in India’s foreign
policy,” he said.
The rupee is Asia’s worst performing currency this year ahead of general
elections due by May where Prime Minister Narendra Modi faces a tough
fight from opposition parties. The yield on the most-traded 2028 bonds was
up one basis point to 7.59 percent, while spreads on State Bank of India’s
2024 dollar bonds widened five basis points.

Some analysts said that strikes may boost equities as it will aid Modi’s
electoral prospects. “The positive perception to the Modi regime will aid
valuations, even as they look expensive,” said Chokkalingam G, managing
director at Mumbai-based Equinomics Research & Advisory Pvt.

Here are more voices from strategists: DBS (Radhika Rao, economist)
Drop in India’s rupee is a “knee-jerk reaction” to the border tensions The
extent of weakness will depend on the Indian government’s rhetoric;
tensions add to worries over the elections that must be held by May DBS
forecasts USD/INR will rise to 73-74 in the next two quarters due to the
election uncertainty and broad dollar strength

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china has been quick to urge both India and Pakistan to exercise restraint as tensions between
the two countries ratchet higher. But what Beijing left unsaid is that billions of dollars worth
of infrastructure projects under its China-Pakistan Economic Corridor (CPEC) are coming up
in Pakistan’s Kyber-Pakhtunkhwa (KPK) province, not far from where Indian warplanes
struck early on Tuesday morning, and they could be jeopardised by any further military
action in the area.

A crucial part of the Karakoram Highway runs through KPK, which borders China’s restive
and underdeveloped Xinjiang Province. In fact, the $1.3-billion 118km-long Thakot-Havelian
road project that’s under construction passes through Mansehra, district where the Indian air
attacks took place. The highway involves complex engineering through hilly terrain end and a
tunnel is being built just 40km from Balakot, which was bombed on Tuesday.
Construction on the Thakot-Havelian highway began in 2016 and is scheduled to finish by
2020. The entire project employs 1,800 Chinese workers and 7,000 Pakistanis though it’s not
clear how many are employed in KPK. The highway is classified as one of the CPEC’s high-
priority Early Harvest Projects and will slash travel time between Havelian-Abbottabad-
Mansehra-Thakot from four hours to one-and-half hours. From the Chinese side, the main
company involved is the China Communications Construction Company.

“We hope that both India and Pakistan can exercise restraint and adopt actions that will help
stabilise the situation in the region and improve relations,” China’s foreign ministry
spokesperson Lu Kang said, according to PTI.

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The $1.3-billion 118km-long Thakot-Havelian road project that’s under construction passes
through the Mansehra district where the Indian air attacks took placeWikimedia Commons
Also, just 48km from Balakot in the Kaghan Valley is the $1.7-billion Suki Kinari
Hydropower Station. The 870-MW power plant is being built on the Kunhar river, a tributary
of the Jhelum and commercial operation is expected to start in December 2022. The power
project is a high-priority Early Harvest Project as well. The hydroelectric project will play an
important role in making KPK almost energy self-sufficient, and at its peak will employ more
than 3,000 people. The main Chinese company involved is the China Gezhouba Group
Company Ltd.
Another big project is the CPEC fibre optic project. Some 287 km pass through KPK. The
total estimated cost of that project is $37 million. The project will help improve Pakistan’s
telecommunications and ICT (information and communications technology) industry. It will
also provide the ICT infrastructure for 3G/4G services in the Northern Areas and enhance
communications security with an alternative fibre route.

The CPEC, details of which became public in 2017, was initially expected to have Chinese
investment worth $62 billion. However, currently projects worth $20 billion are on the cards.
Pakistan, which realised that it could be weighed down by excessive debt, has also
reconsidered some projects.

Tuesday’s attacks underline that the success of the CPEC’s projects will depend heavily on
the region remaining peaceful and free from terrorist activities.

India on Saturday hiked the customs duty on all goods imported from Pakistan to 200
per cent, in the aftermath of the Pulwama terrorist attack that claimed the lives of 40
Central Reserve Police Force personnel.

What does this mean?

In effect, according to agency reports, slapping 200 per cent import duty means almost
banning imports from Pakistan. That is because such a big hike in the customs duty will
drastically increase the prices of Pakistani goods coming to India, thereby making them
far less competitive against other imported goods.

How is this linked to India withdrawing MFN status to Pakistan?

The duty hike came a day after India withdrew the 'most-favoured nation' (MFN) status it
had granted to Pakistan. The move, as reported earlier, enabled India to increase
customs duty on goods coming from the neighbouring country. India had granted MFN
status to Pakistan in 1996. However, Pakistan had not extended the same status to
India.

The World Trade Organization's (WTO's) General Agreement on Tariffs and Trade
governs the specifics of what it means to grant MFN status to a country. In essence,
countries that are a signatory to the agreement have agreed not to discriminate against
each other and the rest of the WTO member nations.

What will be the impact on Indian trade?

The numbers tell the story. Bilateral trade between India and Pakistan in 2017-18
stood at $2.4 billion, which amounts to just 0.3 per cent of India's overall merchandise
trade.
India's exports to Pakistan stood at $1.9 billion that year, or just 0.63 per cent of its total
exports. Imports from Pakistan amounted to $488 million, or 0.10 per cent of India's total
inward shipments.

What other measures can India take against Pakistan on the trade front?

In the wake of the attack, government officials told Business Standard that India is
considering suspending trade ties with Pakistan. Any decision to stop exports to
Pakistan will likely affect its cotton industry, which relies on cotton bales sourced from
India.

Further, Pakistan is also dependent on cheaper varieties of Indian pharmaceutical

products and machinery items, which it will find difficult to source from other countries.

Financial Action Task Force to be given dossier to blacklist Pakistan for terror
links

Moreover, India is further expected to seek Pakistan’s blacklisting in the upcoming

Financial Action Task Force (FATF) meeting, and according to reports, Indian agencies
are already busy preparing a dossier to establish Pakistan’s culpability in the recent
Pulwama attack. Pakistan is currently on the FATF grey list. The meeting is taking place
on February 17-22 in Paris. An Economic Times report said India will also impress upon
the European Commission to act on its proposal to blacklist Pakistan. The commission
typically does that to countries on the FATF grey list.

A country is placed on the FATF blacklist if it is deemed to be "non-cooperative" in the

global fight against terrorist financing and money laundering. If the FATF blacklists
Pakistan, it could lead to a downgrading of the country by multilateral lenders such as
the International Monetary Fund, World Bank and the Asian Development Bank. It may
also lead to a reduction in risk rating by ratings agencies such as Moody's, S&P and
Fitch.

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