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The shock waves from India’s Red Corridor failed to dampen bullish sentiment as the Indian stock market began celebrating key year-on-year data yesterday. Maoist guerrillas blew up railway tracks, burnt down train stations and destroyed transmission towers across the states of Bihar, Jharkhand, Orissa and Chattisgarh. But the Sensex index still surged past the 17,000 mark on impressive industrial production numbers.

Industrial output grew by 10.4% in August (year-on-year) as stimulus money revived demand for household goods and cars. “Foreign institutions have invested more than $12 billion in the Indian stock market during the first nine months of this year based on valuations,” said a senior officer responsible for foreign accounts at Citibank, Mumbai. “With blue chips yielding as much a 17% return for the third-quarter period, we expect sentiment to remain positive well into 2010.”

With the Indian government preparing for a full-scale assault on armed combatants across the Red Corridor within weeks, it is difficult to see how foreign sentiment will remain positive. The Indian Prime Minister has publicly acknowledged that left-wing extremism is the biggest threat to national security. “The Maoists have refused to come to the negotiating table, so we have no choice but to launch military operations now,” the head of the Interior Ministry declared at a press conference last Friday. New Delhi expects to deploy at least 30,000 highly-trained forces, in addition to substantially upgrading local police capabilities.

Will a prolonged war of attrition in the Red Corrider - stretching from Maharashtra and Andhra Pradesh in the West and South to Bihar and West Bengal in the North and East – slow foreign fund inflows to a trickle and, in fact, create waves of profit-taking during periods of intensified conflict? In all likelihood, foreign asset mangers will look for guidance to multinationals committed to making direct investments in India, particularly those companies whose projects are located in heart of the zone of conflict.

General Electric (NYSE:GE) plans a massive $600 million plant to manufacture diesel locomotives in Bihar’s Saran district, which borders areas heavily influenced by the Communist Part of India (Maoist); while the official version is that the project was placed on hold due to uncertainties governing the last general elections, it is common knowledge that GE’s public sector partners are reassessing their strategy in a region which is historically both, resource-rich and poverty-ridden.

Last month, executives of Areclor Mittal (NYSE:MT), the world’s largest steel producer, leaked news of a decision to abandon $20 billion worth of steel projects in Orissa and Jharkhand due to difficulties in obtaining suitable land. “In reality, Areclor Mittal was highly uncomfortable with the ongoing tension on the ground,” said MT's local agent standing near a town hall which was attacked by Maoists (also called Naxalites) the previous night. A Canadian mining company, citing prohibitive “security costs”, has recently made a decision to sell its stake in two large iron ore mining concessions along the Chattisgarh-Orissa border. And few doubt that, despite the impending government offensive, the list of departing foreign companies will keep growing in the foreseeable future.

Intelligence estimates of hard-core Maoist numbers vary, from a low of 7,000 to a high of 30,000; but district-level paramilitary commanders are alarmed by the fact that guerrilla leaders can easily muster 200-500 poor farmers and tribal youth each time they decide to attack a police outpost or railway station. “We have come to expect reports of a fresh wave of such attacks in the daily morning news bulletins,” said a Mumbai-based analyst for a New York investment bank. “It is impossible for sentiment not to be effected when a mini-war is in progress in the Indian hinterland,”

For the present, however, the bullish sentiment is intact, barely, and international fund managers are regarding the dangers of left-wing insurgency as part of the risks associated with the hunt for spectacular gains in emerging markets. After all, India is not, by any measure, on the verge of a communist revolution. On the contrary, the challenge is more commercial in nature. Will the Maoist ability to regularly wreck havoc on the communications infrastructure – railway lines, transmission structures and roads (blockades) – dampen direct foreign investment in the vast Red Corridor and push equity traders to book profits whenever the Sensex index scales new heights?

Disclosure: Short INP, MT and PIN

Source: Maoist Conflict Threatens Indian Stocks