India Risk Rises as Pakistan Unravels

Last week, as Standard & Poor’s revised its India outlook to negative (from stable), credit default swap spreads for State Bank of India and ICICI Bank (IBN) rose to levels not witnessed since last November. Today, as Pakistan’s opposition parties start their “long march” to Islamabad, Pakistan’s capital, default risk buyers for both India and Pakistan have retreated altogether. Depending upon how unstable Pakistan looks by the end of the day, sovereign risk perceptions for a number of Asian countries will deteriorate dramatically going into the weekend.

Last June, shortly after Taliban militants burnt down the ski resort of Malam Jabba, in the Karakoram mountain range, an Austrian snow-making expert fleeing Pakistan declared that “Washington needs to understand that the war on terror has reached the heavily populated regions of Pakistan and the focus on the border regions is totally misplaced.” The Malam Jabba ski slopes are in the vicinity of the picturesque Swat Valley, in Pakistan’s North West Frontier Province; the Swat Valley is under the control of Islamic radicals following a “peace deal” with the Pakistan government. Malam Jabba, or whatever is left of it, now serves as a training camp for fighters loyal to Mullah Fazlullah-nicknamed Mullah Radio due to his habit of taking to the airwaves at the slightest opportunity-who runs a fundamentalist outfit banned by Islamabad.

Few knowledgeable observers of the post-9/11 war on terror doubt that increasing instability in Pakistan will not only turn President Obama’s Afghanistan strategy into a non-event. But also at stake is the impact the instability in Pakistan will have on its neighbours (e.g. Afghanistan, Iran, India, Central Asia and Far-Western China) and on countries with powerful Islamist movements (e.g. Egypt, Bangladesh, Indonesia and Somalia). While the Obama Administration is targeting Osama Bin Laden and his Al Qaeda cohorts, the street-level threat from poverty-stricken Muslim neighbourhoods everywhere is increasing with each passing day. “The most immediate area of concern, of course, is India,” a Hong Kong-based CDS price-maker conceded. “I see India default risk widening sharply as traders get a grip on the building crisis in Pakistan.”

Five-year CDS spreads on State Bank of India breached 500 basis points in Asian trading. ICICI Bank is being quoted at 750-800 bps. Both banks are viewed as proxies for India sovereign risk, which is already under pressure from the global credit crunch. Economic analysts in Mumbai and New Delhi were reluctant to go on record with their views on how the conflict in Pakistan could or would influence India in the near-term or medium-term. But the strife-torn province of Punjab has a lengthy border with India, the Swat Valley is less than 600 km from major Indian towns and, perhaps most importantly for both India and the West, heightened political unrest will bring back into play the question of control over Pakistan’s nuclear assets.

By 0400 New York time, the Pakistan government had ordered the arrest of hundreds of opposition activists and lawyers. Thousands of protestors had gathered in Karachi and Quetta to begin the long march to the capital. From an undisclosed location, Pakistan’s legendary cricketer-turned-politician, Imran Khan, warned that “the situation could spin out of control, into a speedy downward spiral, at short notice.” And, as if to complicate matters, those currently directing the protests in numerous locations are hardened members of Pakistan’s oldest Islamist organization, the Jamiat-ul-Islam.

The Indian stock markets were surging in early trading today, but there is every reason to conclude that India-based ETFs and ETNs (EPI, ICN, INP, PIN) remain solid short propositions on any rallies from yesterday’s closing levels. The risks in a short-India trade are very limited indeed, particularly with the uncertainty surrounding the Indian general elections in April and May.

This writer is of the view that the trouble in Pakistan is grounded solidly in the failure of successive Islamabad governments to attack the problems of impoverishment and illiteracy with any commitment whatsoever; so, wherever the long march ultimately ends up, one cannot look forward to anything but chaos in the weeks and months ahead. And the effects of continuing anarchy in Pakistan will certainly be felt beyond India. “As Pakistan goes, so goes the global war on terror, globally,” Mr. Khan told this writer before rushing off to another undisclosed place.

Disclosure: Author holds short positions in IBN, ICN

Comments

[Doc 224899:]

Fundamentalist Islam doesn't tolerate political, social, economic, or legal interventions that would correct the problems of "impoverishment and illiteracy", or "anarchy", in Pakistan.

It doesn't matter if fundamentalist Islam is in Pakistan, Afghanistan, or India. It has the same effect everywhere it flourishes.

The Islamist-fueled instability in Pakistan and Afghanistan bleeds over into India, where Muslims are the second largest religious/political group, and contributes to India's inability to organize and operationalize an economic growth trend consistent with the country's potential.

All economic and political initiatives that fail to address these fundamental facts are doomed to failure.

President Obama's newly announced intent to negotiate with "moderate" Taliban either reflects his ignorance of these facts, his willingness to ignore these facts, or his inclination to negotiate with and appease Islamic terrorists (as predicted by the neo-cons).

Mar 12 10:03 AM

[Bones:]

Thank you Rakesh. Another great piece.

Mar 12 11:06 AM

[Rakesh Saxena:]

DevKumar: If you were to become Prime Minister of India, then I may have to surrender to the Indian police also. You are scaring me. Please show some mercy.


On Mar 12 11:59 PM DevKumar wrote:

> Loser PROXIMO
>
> Are you Rakesh Saxena ? why don't you surrender to Thai Police.

Mar 13 01:01 AM

[Alan Young:]

I wish I could say that I found this article informative and helpful. However, every article I have ever seen by Mr. Saxena is a recommendation to short. Mr. Saxena, if you have written articles in the past that have pointed to long opportunities, please direct my attention to them so that I can get some perspective. Identifying "risk" is an important contribution; but why should I believe an analyst who says everything should be shorted, any more than I should believe one who calls everything a "buy"?

Mar 13 01:57 AM

[Rakesh Saxena:]

Dear Aalan: You raise a good question, and I should make two points in reply. Firstly, given my fundamental view that systemic risk globally has not been contained, and will not be contained for quite a while, I am not inclined to buy anything at this point. Secondly, since my core business is default risk and index put insurance pricing, I am assessing short selling windows all the time. I am not a value investor, and I don't as a rule make long-term "long" recommendations. I trust that provides the clarification you are seeking. Many thanks - Rakesh

On Mar 13 01:57 AM Aalan wrote:

> I wish I could say that I found this article informative and helpful.
> However, every article I have ever seen by Mr. Saxena is a recommendation
> to short. Mr. Saxena, if you have written articles in the past that
> have pointed to long opportunities, please direct my attention to
> them so that I can get some perspective. Identifying "risk" is an
> important contribution; but why should I believe an analyst who says
> everything should be shorted, any more than I should believe one
> who calls everything a "buy"?
>
>
>
>

Mar 13 02:23 AM

[Rakesh Saxena:]

Dear Juan77: I don't know of any short India ETFs--but perhaps you can search this site for more information on the subject or ask one of the SA editors. I could not agree with you more on the inflated asset values in India. Many thanks - Rakesh


On Mar 13 02:12 AM juan77 wrote:

> Hi Rakesh, thanks for another nice article.
> I think the word hyper inflation sums up the situation in India -
> because asset prices were super inflated fueled by hype!
> Are there any short India ETFs?
> I look forward to your articles ever since I read your article where
> you predicted(very correctly) that BAC would fall to $5.

Mar 13 02:26 AM

[Shiva:]

Linking Pak's turmoil to India's CDS spreads is a bit far fledged. India, just like other nations is reeling under weak exports,a ballooning current deficit and a weak employment scenario, with another factor thrown in- ELECTIONS. In the past few decades India has come a long way, totally dissociating itself from the Pakistan trouble. Its true that a collapse of Pakistan will spell trouble for INDIA, but tell me who is safer if such a thing happens especially given their nuclear capabilities? Hence I feel that linking security risk with its economic risk is a bit of a stretch. It can be true in case of Pakistan due to the total collapse of the administration over there, but not in case of India which is a thriving Democracy.

Mar 13 02:45 AM

[1worldcurrency:]

Why not short everything when it seems that most paper "assets" are merely thinly-veiled Ponzi shells?

What public corporation in history has EVER paid off all its debts and dissolved?

Mar 13 05:34 AM

[Chris B:]

Foreign policy troubles and even horrific terrorism are great misfortunes for sure, but do not necessarily cause stock price declines.

Take the US for example, where the market bottomed in 2002 and rose sharply from there, despite the recency of the 9/11 attacks, an ongoing multi-trillion dollar war in Afghanistan, and with another multi-trillion dollar war with Iraq imminent. Meanwhile, the Bush administration was openly planning for yet another war: this time with Iran. Despite trillions of dollars being added to the national debt and despite an unpredictable administration that had been revealed to be falsifying intelligence information to start the Iraq war, the stock market advanced quickly, fueled by revenue growth in real estate, resources, technology, retailing, and finance.

That is... until 2007-2008, when it became clear that the Iraq situation was calming, Al Quaeda was weakening, and that enhanced security procedures at airports and elsewhere were successfully preventing more terrorist attacks. The markets rose despite a deteriorating security situation, and they fell despite an improving security situation.

India's successes or failures in business will be based more on their internal actions than on the actions of foreigners, just as it was in the US. Whether their government choses to waste massive amounts of money on hysteria-driven wars remains to be seen, but there appears to be no direct connection between that and stock prices, at least in the short run.

Mar 13 09:58 AM

[DevKumar:]

What's the difference between Osama Bin Landen and Rakesh Saxena ?
Both of them are criminals somewhere.

Mar 13 09:30 PM

[DevKumar:]

Rakesh Saxena - most wanted criminal in Thailand.

check for yourself.

en.wikipedia.org/wiki/...

Mar 13 09:31 PM

[shisya:]

Devkumar:

Makes me wonder what exactly is your motive to come on here and start this?

Either ways lets just stay on the topic here please. Please take the right channels to further your case, SA just doesnt happen to be one of them.

Mar 16 05:56 PM

[DevKumar:]

My motive is to save investors from financial terrorists like Rakesh Saxena.

He is a criminal and belongs in jail.

Mar 16 10:37 PM

[User 379552:]

I disagree with your premise of risk for India based on Pakistan's problems. Pakistan is no match for India, even though they have nuclear weapons ETc., as you mention in your article. The Indian stock market took off when fed cut the interest rate(by the way, I believe, Bernake should have been kicked out of his FED job long ago) in Sept 2007, Indian stock market's bubble started and continued just like the US stock market when Fed fool cut the interest rates(like crazy) whenever the futures were down big time before the market open. This idiot is now spending $1.2 Trillion which will drive the world economies further down including the USA. The Indian banks were identified by ignorant short sellers with US banks who could have been destroyed if the bank had managed the stock like many US companies do. IBN still earns $1.6. Your theory is wrong for this story. If you are not from India, may be you should learn the history at least since 1950 and make conclusions. If it was your attempt to infulence people to short IBN, I frankly do not care because it really does not matter.

Good Luck!

Mar 19 07:25 PM

[PROXIMO:]

Rakesh--Enjoyed the article. When are you going to post again? I need my fix. I'm concerned I may have withdrawls(just kidding). Although some of what you write typically goes over my head, I also learn much from your writings. I also very much enjoy articles on SA by Greg Weston, Andrew Left, John Lounsbury, Steve Hansen, Thomas Ryan, Charlie Bottle and Vinard Dar. I received an MBA from a small accredited college in Texas several years ago, but in my opinion, there is far more solid actionable investment advice/information on SA than there ever was in the academic world. Keep up the good work and thanks. Prox

Mar 26 01:15 PM