A Tale of Two Markets Amidst Geopolitical Storm

Imagine families going on a vacation, excited to celebrate their anniversary, retirement, or even spend time together. But then, that trip turns out to be the worst nightmare of their life. What was supposed to end up with beautiful memories instead ended up with women being widows and children returning with a single parent. Yes, you guessed it right. It is the notorious Pahalgam attack. India has been at the receiving end of terrorism for nearly five decades. From the Parliament attack in 2001 to the Pulwama terrorist attack in 2019, India has borne enough.

And that’s how Operation Sindoor unfolded- India's unwavering response to escalating cross-border terrorism.

Pakistan, a nation with $131 billion of external debt as of December 2024 and a mere $15 billion of foreign exchange reserves, has witnessed economic challenges and instability over the past few months. The impact on the Pakistan Stock Exchange (PSE) in the wake of Operation Sindoor has been deeply concerning. Back in 2023, the country had almost gone bankrupt, making a fragile recovery under a $7 billion bailout programme from the IMF, along with debt rollovers. But now, they risk going down the road of severe destabilisation. Triggered by Prime Minister Narendra Modi’s warning on attack and India’s military response, the Karachi Stock Exchange (KSE) has plunged around 9% in the last two days alone.

There are a few reasons for this stock market crash in Pakistan. Firstly, the India-Pakistan relationship has been hostile and complex from the very beginning. There have been constant accusations and demands by countries like India and the US that Pakistan stop using its territory as a base for terrorist groups following multiple terrorist attacks. The military operation by India, a neighbouring country of Pakistan, injects a high degree of economic uncertainty. Investors fear prolonged conflict, increased military spending and diversion of crucial resources. Secondly, the country has been in a fragile state. Soaring inflation, depreciating currency and excessive reliance on external bailouts make the country a risky option for investment. The termination of the Indus Water Treaty of 1960 and Pakistani airlines' ban on using India’s airspace further increased investor distrust. To worsen the situation, India is expected to contest a proposed line by the IMF for Pakistan.

The current state of the market depicts a deep concern among investors regarding the economic resilience of the country and the ability to withstand a prolonged war.

In stark contrast to the turmoil in Pakistan, the Indian Stock market has shown remarkable resilience. Nifty has risen over 1% since the Pahalgam terror attack. On the day of Operation Sindoor, it closed in green, but as the situation escalated, it closed in red on May 8, still higher than the Pahalgam incident.

This suggests a belief and confidence among the investors regarding India’s strength. Again, this belief is backed by a few factors.

Firstly, India's diversified economy provides a significant buffer against external shocks. Currently, it is the 5th largest economy (in terms of GDP)  in the world and the fastest growing major economy. India’s GDP and forex reserves are 10.5 and 35.52 times the size of Pakistan, respectively. India’s $4 trillion economy has limited trade with Pakistan, therefore having limited immediate impact on factors like currency, equity, etc. Secondly, the history of India-Pakistan conflicts showcases a pattern of short-term market volatility.

During the Pulwama attack in 2019, the rupee held steady, and although the bond yield increased a bit, it retreated later. Thirdly, the country’s focus on closing trade deals is vital in shaping investor outlook. India’s recently sealed trade agreement with the UK and ongoing discussions for a bilateral trade agreement with the US testify to the fact.

Therefore, the overall sentiment around the Indian Stock Market appears optimistic. The focus remains on long-term growth and proving to the investors that the country can get past this geopolitical storm.

Foreign Direct Investors’ (FDIs) response to the operation Sindoor further showcases the different perceptions regarding India and Pakistan’s economies. According to UNCTAD, “Foreign direct investment (FDI) is defined as an investment involving a long-term relationship and reflecting a lasting interest and control by a resident entity in one economy (foreign direct investor or parent enterprise) in an enterprise resident in an economy other than that of the foreign direct investor (FDI enterprise or affiliate enterprise or foreign affiliate).”

In the case of Pakistan, escalating tension is likely to deter new inflows and even lead to potential outflows. The poor situation of Pakistan's economic growth and the overdependence on economic sanctions could lead to a slowdown or even a reversal of FDI flows. Conversely, India’s record of resolving geopolitical disputes will likely maintain its attractiveness as an FDI destination. Although immediate, full-scale escalation might lead to a slowdown, India's large market size and growth potential will continue attracting long-term foreign investment. Long-term investors focus on India's trade deals, consumption, and government policy initiatives.

Therefore, the expected behaviour of FDI reflects a declining interest in Pakistan due to its economic fragility and risks and a sustained, perhaps temporarily cautious, interest in India.

The contrasting reactions of the Pakistan and Indian stock markets indicate a tilt in international confidence towards India as the preferred investment destination between the two countries involved in the geopolitical dispute. According to a warning by Moody's, "Sustained escalation in tensions with India would likely weigh on Pakistan's growth and hamper the government's ongoing fiscal consolidation, setting back Pakistan's progress in achieving macroeconomic stability." Given that Pakistan is in debt and struggling to implement reforms needed by the IMF, a military conflict at this point would be detrimental.

To conclude, Operation Sindoor, while showcasing India’s stance on cross-border terrorism, also highlights the investor confidence between the two neighbours. The financial markets indicate a clear verdict: India's stronger fundamentals and focus on growth in times of geopolitical distress make it a more attractive destination for international capital. The story of two markets during Operation Sindoor serves as a reminder of how geopolitical developments can highlight underlying economic strengths and weaknesses, affecting investor sentiment and the movement of global capital.