India's worst-ever coordinated terrorist attacks on key sites in Mumbai, the financial capital of India, have left the people and the government shell-shocked.
The most serious irreparable loss will be in terms of innocent human life--the official death toll is approaching 200, but the actual figure could be much higher.
But investors--both foreign and domestic--are also likely to be concerned over the direct and indirect economic fallout from these attacks, especially as it caught the government and the intelligence agencies napping.
Further, the political implications of the terrorist attacks could be meaningful in light of several state elections that are already underway, and also for the general elections that have to be held by May 2009.
India and its people are documented to recover quickly from adverse shocks (recall the infamous floods in 2005 that brought Mumbai to a standstill for several days).
The direct and indirect, and the short- and long-term effects of the economic fallout of the attacks will likely be transmitted via two main channels: (1) the very near-term impact on financial assets, which in India's case would be equities and the rupee; (2) the medium- and long-term impact on greater investment into the country, either by existing foreign firms in India expanding their operations, or by new companies captivated by the emerging strong domestic demand, especially the rise of the Indian consumer and the estimated 200 to 300 million strong middle class.
The negative effects of the current attacks on tourism (winter months are the peak tourist period for India), investor confidence, rupee and equities will likely be temporary, as was the case in the aftermath of past attacks.
However, the gravity of the latest attack could potentially have two lasting negative effects, both of which will be partly a function of how strongly the government responds to the rising threat and the increased reach of terrorism.
One, foreign investors will likely to be worried about the safety of their employees and their establishments. Continuation of a soft approach by the government will only further dent foreign confidence, which in turn could hit the flow of foreign direct investment into the country.
In the first half of 2008-2009 (the fiscal year runs from April to March), India received an FDI inflow of $19.3 billion, an impressive increase of 166% from the same period a year ago. The unfolding global crisis will itself hurt FDI flows into India, but the hit to investor sentiment following the Mumbai attacks could further amplify the knock.
Two, tourism (domestic and foreign) could suffer longer-term damage if the government does not get its act together and respond in a manner that makes tourists feel safe. For example, increased terrorist attacks in Kashmir over the years pretty much killed the tourism industry there.
Unlike several other Asian economies, foreign tourism for India is not huge relative to the size of the over $1 trillion economy, and is unlikely to be a serious hit for the immediate outlook for economic growth.
Foreign tourist arrivals were 4.3 million in January to October 2008, and foreign exchange earnings were around $9.7 billion in that period. There is great scope to increase tourism flows that will be favorable for local businesses and job creation, but neither positive will emerge if the government does not move convincingly to make tourists feel safe.
Economic growth is already slowing down and is poised to hit a seven-year low of 6% (year over year) next year, after being 9.3% per annum in the three years to 2007-2008.
The Mumbai attacks do not significantly increase the near-term downside risk to growth, given that tourism is only a small part of the economy. It is too early to establish with strong conviction that the short-term negative reaction of investors and investment flow will turn into something that will be more permanent.
The government's security track record will come under greater scrutiny, but unfortunately, the current government has little to show for in how it has tackled the issue effectively.
In the absence of a strong and unified response against terrorism--not against a particular country or two--the safety of investments would be in question, and the adverse effects will become more broad-based.
India is becoming more integrated with the rest of the world, and there is thus a greater potential hit to the economy if foreign investors vote with their feet.
Tourism, IT and software industries, business process outsourcing (BPO) and local manufacturing could be among the businesses that are vulnerable. Even if there is no direct threat to a particular business, say, BPO, there could be relevant contingencies if, for example, there are attacks on infrastructure that these companies rely on.
The political fallout will almost certainly be negative for the current coalition government led by Manmohan Singh that has been criticized by the opposition for its soft approach in dealing with terrorism.
Singh delivered a robotic and an insipid speech on national television. He reportedly indicated "strong action," but it remains to be seen if these will turn out to be paper tigers. The collapse in security for the average Indian is just another breakdown in the broader degeneration of basic public service that voters rely on.
The political hit from the Mumbai attacks should not be underestimated: Security-related concerns have been an important worry for voters, and the latest liability from Mumbai for the ruling government follows earlier worries over unacceptably high inflation that was replaced by the negative impact of the global credit crisis on economic growth and job creation.
The list of negatives against the ruling government appears to be increasing, even as some key state legislative elections are underway, which in turn could affect voter reaction in the run-up to the general elections that have to be held by May 2009.
Declining inflation and increased downside risk to growth hint that another round of easing by the central bank is imminent.
However, the Mumbai attacks could prompt the central bank to announce a bigger cut than the 50 basis points that were expected prior to the attacks. But the ultimate medicine is with the government, and it will be critically judged by its response.
Rajeev Malik is head of India and ASEAN economics at Macquarie Capital Securities, Singapore. All views expressed in this article are personal.
