Why “Surgical Strikes” And War Talk Will Not Dent The Economy Or The Sensex

On 29 September, when news about India’s “surgical strike” across the Line-of-Control in Jammu & Kashmir broke, the stock markets crashed, with the Bombay Stock Exchange Sensex falling 465 points. The rupee too crashed by 39 paise to Rs 66.86 to the US dollar.

Both the markets and the rupee have since recovered. But the big question remains: does the prospect of a wider war of attrition impact the stock markets? And will the economy too slide as a result?

There cannot obviously be a straightforward yes or no answer to this question, for a lot depends on how we deal with the escalation, and what kind of resources get channelled to feed mini war preparations. But Sensex 30,000 should very much be achievable by March 2017, and the index could well head higher next year, as money from the Seventh Pay Commission powers higher consumption and foreign capital inflows power the indices.

But there are three points to be made:

One, our own experience during the last war – Kargil – shows that a half-war does not always damage the economy or the markets. In fact, during 1999-2000, even as the Kargil conflict was going on between May and July 1999, the Sensex actually gained 38 per cent, according to a report in The Economic Times.

As for the economy, India recorded 8 per cent GDP growth in that year – one of the highest achieved by the Vajpayee-led NDA. This does not mean the war had no impact, but a continental-sized economy is less impacted by limited war than a small one. Other economic factors neutralised the impact of war spending. This year, the good monsoon will overcome any short-term blips due to terrorism or war-rhetoric.

This was borne out during the early years of the US war on terror, from 2001-2005. During those years, as the US went into Afghanistan and Iraq, US GDP started rising, from 1 percent in 2001 to a high of 3.8 percent three years later, before tapering off. War spending often boosts an economy in the short run. The economy was brought down later by the sub-prime crisis, but that was a self-goal.

As far as India is concerned, we have been facing low-intensity war – through terrorism and the Kashmir eruptions - regularly, and this has not impacted our growth trajectory or market sentiment. A limited war after the Uri terror attack may thus not impact either the Indian economy or the markets unless it becomes full-scale war – which seems unlikely.

Two, in a global situation where almost no country is growing robustly and interest rates are near zero in large parts of the Western world, India will actually attract capital this year and the next. In the year so far, India has attracted $7.5 billion in stocks and almost nothing in debt. But if Western rates continue to be zero or negative, more money will also come into debt. Reason: as rates look set to ease, bond prices will rise and investors may want to lock into these gains. We should thus see markets stable, if not rising, even if there is a limited war.

Three, domestic money is also going into stocks. While the Employees’ Provident Fund Organisation (EPFO) has been allowed to invest upto 10 per cent of its corpus into stocks through exchange-traded funds (ETFs), Indian retail investors are increasingly SIP-ping equity – through systematic investment plans (SIPs). The current estimate of monthly inflows into equity mutual funds is around Rs 3,000 crore. This means over and above foreign inflows, domestic equity inflows are also rising. The Indian obsession with debt mutual funds and fixed deposits is reducing, and The Economic Times reports that 30 per cent of equity funds (value: over Rs 4 lakh crore) are being powered by SIP inflows. The EPFO, on the other hand, will be able to invest upto Rs 13,000 crore in equity this year if it wants to.

Mark Mobius, Executive Chairman of Templeton Emerging Markets Group, told CNBC TV-18 recently that the recent border operation will not have a major impact on Indian shares, and investors were looking at reforms and not small-scale conflicts to decide where to put their money. With the Modi government focusing on implementing the goods and services tax from 1 April 2017, foreign investors may look at any drop in market prices to buy rather than sell.

In short, the war talk in Delhi is unlikely to dampen the mood in the stock markets. But volatility, whenever there is a terrorist event, can’t be ruled out.