Strategy Note /

India, Pakistan: Escalation, emotion, context and MAD

    Hasnain Malik
    Hasnain Malik

    Strategy & Head of Equity Research

    Christopher Dielmann CFA
    Christopher Dielmann CFA

    Director, Macroeconomic & Sovereign Research

    Tellimer Research
    17 February 2019
    Published by

    India-Pakistan tensions could escalate, but up to a limit. The terror attack against Indian security forces in Pulwama, Jammu and Kashmir, in India, obviously ratchets up geopolitical risk in the region (risks of “retaliatory surgical strikes”, exchange of fire across the border, covert attacks). It may have negative repercussions for the foreign perception of the investment case in Pakistan, an equity market that we regard as cheap and a sovereign US$ credit market we regard as fair value, but in both cases, in need of an IMF-deal catalyst. More broadly, we view Pakistan as being in the midst of seismic, positive structural change. Periodic escalation in tension between India and Pakistan is nothing new and nuclear capability on both sides should continue to establish a limit on any conflict resulting from these tensions.

    Differences this time round. What is different in the current environment, from the Indian side, is the unexpectedly competitive election that the BJP find themselves in, which may prompt a more acute escalation than at other times. What is different, from the Pakistan side, is the recent overlap of Pakistan’s interests and those of the US (however temporary) as it negotiates with the Afghan Taliban, and those of Saudi-UAE (likely much more sticky) as the two Gulf countries begin preparations for a long-term without a US security blanket to counter the threat of Iran. Whether the BJP in India has more to gain from an escalation in tension (conflict) than military or civilian leadership in Pakistan does, is ultimately a moot point in the context of our analysis. Could tensions escalate? Yes, but there are structural reasons why there is a limit to how far.

    Competing narratives, as always. We note that there are two competing narratives following the attack:

    1. The narrative from India and the US is that this is an attack on Indian sovereign territory, conducted by a member of a terrorist organisation based in Pakistan, where that organisation enjoys sponsorship from Pakistan’s intelligence and military, and that this follows a long historical line of similar attacks. 
    2. The narrative from Pakistan is that this is an attack on land long occupied, in a brutal and unchecked manner, by India and conducted by a disaffected, radicalised member of the local population.

    Beyond identifying these competing, highly sensitive, narratives, we have no business in adjudicating between them. Instead, we situate these narratives in the context of eight factors below. Without due regard for these factors, investors will likely extrapolate an incomplete picture from simply focusing on the public narrative of both sides.

    The context for the rhetoric, 8 factors to consider:

    1. Long history of minimal trade, much mutual covert and overt destabilisation and occasional hot military conflict between India and Pakistan. 
    2. Ultimate path to mutually assured nuclear destruction (and, therefore, a limit to how far military conflict can progress).
    3. Broader regional juxtaposition of China-Pakistan on the one side and US-India on the other, where there are many “middle-grounds” for this rivalry, e.g. Afghanistan, Balochistan, Bhutan, Iran, Kashmir, Maldives, Myanmar, Nepal and Sri Lanka. 
    4. Recent alignment of US and Pakistan interests in negotiations between the US and the Taliban in Afghanistan, after years of conflicting interests. 
    5. Recent alignment of Iran and India interests on oil supply and foreign investment by India into Iranian ports. 
    6. Recent re-alignment of Saudi, UAE and Pakistan interests, following the former’s security concerns over Iranian hostility and US long-term commitment to the region, and the latter’s urgent need for financial support. 
    7. Vulnerability of foreign trade and investment in Pakistan (the portion not driven by geopolitical friends) from either targeted sanctions (akin to those applied to Turkey or Saudi Arabia in 2018) or a setback at the FATF (Financial Action Task Force, the multilateral body which supervises anti-money laundering and terror financing safeguards). 
    8. Imminent election in India (April-May 2019) where the BJP, led by incumbent PM Modi, is in the midst of a far more competitive campaign than it might have expected a year ago (evidenced by setbacks in state-level elections in Chhattisgarh, Madhya Pradesh and Rajasthan) as the opposition Congress have exploited discontent over jobs and wages.