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The tensions between Indian and Pakistan which has led to cross border raids and attacks by India and also continued infiltration attacks on army bases in Kashmir has caused a lot of concern. While the tensions continue the question is how is it affecting the economy in short and long term. The finance minister has said that the impact is marginal but the stock markets have been reacting negatively, the business analysts feel that international outlook towards the tension is cautious and wait and watch approach is being adopted.
Indian economy is large and it is able to absorb direct and indirect disruptions from bilateral trade in Pakistan which is anyway marginal. Major impact is happening on the investment climate in India because the tensions due are perceived as causing instability in south Asian region and investors are bound to take wait and watch approach.
There is diversity between Indian and Pakistan economy. Pakistan’s economy is smaller and less diverse and agrarian compared to India. The water also flows down from India to support the agricultural activities in Pakistan. Thus impact on Pakistan’s economy is more adverse than in India if tensions continue to remain. The government expenditure in Pakistan and India would get impacted if there is a war. India is also currently passing through a stage where private investment is lagging behind. To keep India’s growth ratio and investment ratio up, India is dependent upon public investment right now.
Similar tensions have been witnessed before. But there is difference between then and now.
At this point of time there is not going to be substantive effect on economy. It is the sentiment which is going to get affected most probably, especially, for foreign investors as with heightened political risks, they would rather wait for the things to settle down before putting in more money in India. The same goes for new investors within domestic investment as well. No one wishes to invest in economies where political risk is heightened as political risk translates easily into commercial risks.
The benefit from the government which is perceived to be strong and decisive is also a positive sentiment that goes into the economy. That sentiment was there, but with the ongoing political blame game and political discussions taking place, the government should provide a big spur to the economic activities because everybody wants a strong and decisive government.
A greater economic relationship between India and Pakistan is an opportunity lost as it is a setback to the economy. The potential to both economies to have more bilateral trade which could give boost to economies on both sides, direct route to Afghanistan and flights curtailment which is now going to take place by taking longer detour are added costs on account of that. These are negative things which will happen to Indian economy.
Though investment climate is going to be affected by the skirmishes going on, the larger impact will be on government finances. The government is interested in increasing public investment but now it is under pressure from defence ministry to increase its budget. Around 1.6% of GDP is for defence expenditure in this year and it is expected to increase.
Thus the government which is trying to rein in its fiscal stability but now has to increase public investments, government will be in tight situation on finance side. The continued skirmishes can impact the inflationary environment in the country. There may not be immediate direct impact but higher defence expenditure add to fiscal deficit could lead to higher inflation if these conditions last forever.
Second impact will be that India’s Bollywood will lose an indirect market in Pakistan. Though there is no direct market in there, but through Dubai and other regions, the Indian movie market flourishes in Pakistan. This soft power will be lost by India.
India has 3 types of trade with Pakistan
Direct- 2.5 billion dollars export
Trade through Dubai- 2.5 billion dollars
Barter trade at border- it is not accounted for but there are benign environment of people crossing border, exchanging goods, those could impact the economies of border states. This should not undermine the movement of people which is allowed to take place by border polices on both sides.
It will be affected because people will not take a bet on the Indian economy due to heightened tensions. Regional cooperation and regional trade is cancelled which led to cancel of SAARC summit. It’s a major cause of concern as India’s trade with central Asia will be impacted even more. There were hopes that at some stage Afghanistan and Uzbekistan will compel Pakistan to open its territories with import in India. This is now going to be a non-starter. However, the role that china can play in bringing down tension as it has huge stake in this matter.
If the increased expenditure by defence minister is on increasing supplies produced within the country then that is added fillip to economy. There will be a demand for domestically produced products. But the problem is that 70% of India’s defence equipment is imported which is creating jobs and demand outside the country.
Regional cooperation and regional trade is also affected. Heightened tension between India and Pakistan means all regional issues like regional grid, tackling environment or water issues or trafficking gets affected. That is the major cause of concern.
There is an ongoing World Bank project with electricity trade and export electricity to Pakistan which will also go down.
Over the years, Pakistan has tried to integrate its economy more and more with central Asian countries. Thus, it is getting benefits of regional integration in that area. And thus may not get so affected directly. But potential more trade with SAARC countries will be a setback.
Their fiscal position is not that strong and robust, so crowding out for public investment in Pakistan will be difficult. CPEC is independent of this issue. China will help Pakistan so India will have to see how its diplomatic community deals with it.
Just about year ago there were talks about SAARC currency and MFN. Now India will have the opportunity to look elsewhere, like RCEP, ASEAN, etc. However, many feel that if SAARC doesn’t happen, there is no big opportunity lost. India can exploit larger trading arrangement to increase India’s economy.
Fiscal impact– the pressure on government for defence expenditure will be on capital expenditure side. That capital expenditure, as past tells us, is a long drawn out process. That is not going to be an immediate impact. On revenue expenditures, after 7th pay and OROP, defence ministry will not be asking much. If there is increase in expenditure which uses capacity utilisation in our ordinance factories and domestic production, it will help the economy. It is going to be a good opportunity for more foreign investment on defence side. Government can move faster in that area and the political cobwebs around the FDI in defence may be less which is positive.
Hence, while the impact on overall large economy is not going to be substantial, opportunities will be lost.
Connecting the dots:
How will the economies of India and Pakistan be affected with rising tensions across the border. Discuss.