Business - News Analysis

When war threat is receding

By C. R. L. Narasimhan

An approach that correlates financial markets with political developments to draw conclusions has limitations.

The financial markets' reaction to the recent developments over Kashmir is interesting and has been analysed in detail. It does not need an investment analyst to say that the stock markets as a rule dislike war and the war cries that precede it. Financial markets abhor uncertainty. Not just sentiment but the cost of doing business is adversely affected. For instance, the risk premia associated with many transactions go up automatically. As it happened this time foreign governments advised their nationals based in India to leave. Many overseas visitors called off their plans to the detriment of local business interests. However, it is highly unlikely that anyone could come out with an accurate estimate of economic loss caused on account of the recent crisis over Kashmir. Estimating such loss exclusively on the basis of financial market indices — the fall in the market cap for instance-has its limitations.

Nonetheless, the recent war like situation — now thankfully cooling off — presented an opportunity to correlate stock market behaviour with the threat of war. Although it is the stock prices that are gauged instantly, other segments of the financial sector do send out signals. In reaction to the recent developments, for instance, gold prices shot up to a five year high. That strongly suggested the flight of investors towards a safe haven, which bullion has been the world over in times of uncertainty. However, the rupee's external value did not fluctuate violently as one would have thought it would if the market forces have had their way.

Hence while no sweeping generalisation is warranted it is possible to look at certain broad conclusions. Apparently marketmen took the war cries — from both sides of the border — seriously and the depressed sentiment contributed to a sharp decline in stock prices. Especially on days when a war looked imminent the fall in the indices was more pronounced, even precipitous.

Beginning with May 14 when a suicide squad attacked an army camp near Jammu killing 34 people the stock markets apparently considered the prospect of retaliatory action — whether leading to war or not-very seriously.

Statements by political leaders from either side of the border were strident and almost in proportion the market lost its value. The correlation was established in another way too: the stock markets recovered sharply when the war cries abated.

If the stock markets do not like war, there is no evidence that they thrive in more peaceful terms. It is entirely likely that for the markets the war situation is not an issue any more. Which means that the market mechanism is not always the best guide to matters of state craft.

Even for judging economic strategy the stock markets have been a big let down .All the recent budgets did not impact on the stock exchanges the ways the policy establishment expected them to. Yet the preoccupation with the level of stock indices continues.

Moving to another index which should also reflect the abnormal external situation. The growth in foreign direct investment (FDI) by 66 per cent during last fiscal over the previous year (year ended March 2001) can be interpreted in several ways. FDI inflows have crossed $4 billion last year.

It is claimed that neither the war-like situation nor the terrorist strikes (including September 11) has had an adverse impact. Unlike foreign portfolio flows that affect stock prices and are far more volatile, FDI by definition is stable.

Of special relevance this time are the following: the decision to invest in India is hopefully more considered in the case of FDI. The recent war-like situation might be a dampener but one would think it is too recent to be reflected in last year's tally of FDI.

Second, FDI statistics include flows arising out of M&As and other indirect channels. Last year, for instance, many established MNCs in India delisted from the Indian exchanges by buying out Indian stakeholders. Decisions like that were not affected by the war like situation. For more meaningful conclusions on the effects of the war like situation a greater in-depth study is required.

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