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India and Pakistan: A Peace Payoff

After decades of frosty, and sometimes overtly hostile, relations between India and Pakistan, a warming trend appears to be moving across the subcontinent. Recent dramatic improvement in relations between the two countries promises distinct benefits for the two nuclear-armed neighbors, if the thaw can last and ultimately translates into peaceful relations.

Indeed, the benefits that flow from trade and cooperation can serve to reinforce the peace process, and the tone of recent high-level exchanges suggests that both sides are inclined to embrace this approach, even without a final resolution of the territorial dispute over Kashmir. The likely rewards for Pakistan can be largely defined in concrete economic terms. For India, however, the benefits are of a less tangible nature, and would accrue more to Delhi's international standing.

For Pakistan, the key benefit is the possible reduction in its military spending, which currently takes 25% of the total government budget. Money previously spent on equipping and maintaining its half-million-strong standing army could be funneled toward social needs that would improve the population's living standard and economic productivity. Savings could also be applied toward attaining better fiscal balances, in turn accelerating the reduction of Pakistan's substantial debt burden.

HISTORY OF CONFLICT. Another major benefit for Pakistan from normalized relations with its much larger neighbor would be to unlock the vast potential for cross-border trade and investment. With a land border stretching nearly 1,900 miles and linguistic and ethnic kinship, the opportunities for trade with India are enormous and could rapidly grow from the meager 2% of Pakistan's total trade today. A third, less dramatic, benefit is the revenues that would flow from a natural gas pipeline that will cross Pakistani territory en-route to India from Iran.

India's greatest gain would be its improved standing on the world stage and with the U.S.

For India, the benefits are clearly more on the political side. Although it would see tangible gains from increased trade with Pakistan and easier access to Iranian gas, these would be less significant because of the comparative size of India's economy over Pakistan's. India's greatest gain would be its improved standing on the world stage and with the U.S. This in turn could prove instrumental in better trade and defense relationships with the superpower, and it would also advance India's claim to a permanent seat on the U.N. Security Council.

Along with tensions between the two Koreas, and between China and Taiwan, the dispute between Pakistan and India, which have fought three wars, has been a seemingly intractable conflict and one of the major potential geopolitical flashpoints in Asia. Mutual standoff, interference in each other's affairs, and a bristling arms race have defined relations between the two for most of the past 60 years, keeping the risk of a full-scale conflict and the possibility of a nuclear war at a high level.

IMPRESSIVE THAW. After many false dawns, a better chance that these perennial foes can normalize ties does finally seem more possible. Pakistan President Pervez Musharraf put forward bold proposals for settling the Kashmir dispute, including the possibility of joint administration, and the abandonment of Pakistan's longstanding demand for a plebiscite in Kashmir -- suggestions previously unthinkable from a Pakistani leader. In turn, India began to reduce its troop numbers in Kashmir from November, 2004.

What has allowed Musharraf to cede some ground? The consolidation of his hold on power, Pakistan's improving macroeconomic setting, and ongoing pressure from the U.S. Despite occasional setbacks, India and Pakistan have come a long way since the signing of the Lahore Declaration in 1999, which formally endorsed the need for peace.

Closer diplomatic relations have resulted in a number of events: the exchange of high commissioners in May, 2003; the renewal of a nuclear-weapons test ban by both sides; the setting up of a hotline between the two leaders in June, 2004; and a meeting between Musharraf and Indian Prime Minister Manmohan Singh in India in April, 2005, at a one-day cricket match between the two national sides (see BW Online, 4/14/05, "From Cricket to Kashmir?").

SUCCESSFUL REFORMS. These developments have been matched by confidence-building measures on the ground, including the restoration of direct air services and a Delhi-Lahore bus service, as well as sporting and cultural exchanges. More important has been the considerable progress over Kashmir -- the Gordian knot that caused two of the three wars. A ceasefire along the Line of Control -- a de facto border that divides the Indian- and Pakistani-administered parts of Kashmir -- has been in effect since November, 2003.

Pakistan's recent macroeconomic progress has enabled the country to look toward peace-building moves with India. Economic reforms and responsible fiscal and monetary policies have resulted in robust economic growth, low inflation, and stronger external liquidity. Real gross domestic product growth is set to exceed 6% in the fiscal year ending June 30, 2005, for the second consecutive year, and well above the lackluster 2.8% average growth during 1997 to 2000.

Pakistan's military spending, at 4.5% of GDP, dwarfs its development spending

General government fiscal deficits have been reduced to a manageable level of below 4% of GDP, from close to 8% in 1999, resulting in lower interest rates and a significant easing of the public debt burden. Nevertheless, the level of military readiness necessitated by the state of continuous hostility between the two nations has imposed a heavy burden on the considerably smaller Pakistani economy. The risk of war has constrained Pakistan's sovereign credit rating, impairing the country's access to foreign capital.

TRADE ZONE. With a standing army of almost 600,000, and a reserve force of 500,000, Pakistan's defense budget averaged 25% of total spending, or 4.5% of GDP, over the past eight years. This has dwarfed its development funding, which averaged 13.6%. This is a level of defense spending that Pakistan can ill afford -- it has the lowest per capita GDP among rated Asian sovereigns at $536 in 2004, and the poorest human development indicators, such as an adult literacy rate of 41.5%, and a combined school enrollment ratio of 37% (according to a 2002 U.N. report).

The potential peace dividend for Pakistan is, therefore, substantial in terms of the increased ability to spend on infrastructure, health, and education, improved fiscal balances, as well as a possible trade and investment boom with India. The hostility between India and Pakistan has undermined the effectiveness of the South Asian Association for Regional Cooperation (SAARC) and has delayed the creation of a South Asian Free Trade Area.

If relations are normalized, the free movement of people, capital, and goods is set to boost bilateral trade, which has been suppressed by prohibitive tariffs, a highly militarized border, and severe travel restrictions. Peace would also enable the construction of a proposed gas pipeline from Iran to India via Pakistan, which energy-deficient India badly needs.

STATUS BOOST. Like the tensions between the two Koreas or China and Taiwan, the Pakistan-India conflict is highly asymmetric, given the protagonists' disparate economic size, military capability, and the associated economic and fiscal burden. As a result, the potential peace dividends would also accrue to India, but in a different way. Its standing army of 1.1 million and its defense spending of about 2.4% of GDP suggest its defense burden isn't too onerous.

Therefore, the economic benefits from lower defense spending and access to Pakistan's markets and Iranian gas, while not insignificant, would likely be outweighed by the political benefits, especially the advancement of India's international standing.

Domestically, the conclusion of a permanent peace agreement -- provided it isn't at the expense of a compromise on Kashmir -- would constitute a significant victory for the ruling Congress party. Internationally, a peaceful settlement with Pakistan and consequent removal of the threat of nuclear war on the subcontinent would enhance India's global repuation and would be key to increased U.S. cooperation in trade and defense, both of which are coveted by India. The recent peace progress has already contributed to an improving relationship with the U.S. -- one that has long been characterized by a degree of ambivalence and mistrust.

PRAGMATIC APPROACH. For both India and Pakistan, the economic and political imperatives for achieving lasting peace now appear to be stronger than ever. The cold war era, when India and Pakistan were both firmly ensconced in their respective superpower camps, provided obstacles and no incentive for rapprochement. In the decade that followed the cold war's end, both countries were mired in domestic political strife, while their largely state-run and inefficient economies were stuck in a low-growth rut.

In Pakistan, the current leadership has displayed a great deal of pragmatism in the conduct of both economic policy and its external political relations. This strongly suggests that achieving peace with India is part of its strategy aimed at maintaining and accelerating Pakistan's economic success and its international political ascendancy.

Moreover, dabbling in unconventional warfare against India through the support of separatist groups in Kashmir and India after the September 11, 2001, terrorist attacks has become much less tenable and worthwhile. This, together with the disparate conventional military capability of the two neighboring states, increases Pakistan's incentive for a peaceful and permanent normalization of relations.

After so many false starts, will the apparent thaw turn out differently this time?

On the economic front, India's accomplishments as a rapidly growing and modernizing economy, and its growing international recognition as a globally significant economic powerhouse in the making, are also certain to be getting attention by the Pakistani leadership. Potential benefits from normalized relations with India would, therefore, include the prospect of economic cooperation that could boost Pakistan's long-term economic prosperity and security. This contrasts with Pakistan's other neighbors -- neither the theocracy-ruled and internationally isolated Iran, nor Afghanistan with its medieval economy mired in tribalism and warfare, offer the prospect of such cooperation.

Over the years, the relationship between the two nations has seen many false starts, when peace overtures and apparent thawing quickly unraveled, leading to a return to hostility and the implied threat of a wider conflict. Will it be different this time?

ALTERED LANDSCAPE. Although the peace initiative appears to have both public support and political will in each camp, nationalist and religious zealots on both sides will pressure their respective governments to maintain a hard-line stance toward the other. This could increase if governments are perceived to compromise on Kashmir -- a highly emotional issue in both countries.

Resolution of Kashmir's status is therefore a necessary condition for a full-fledged peace accord, which, given the complexities and seemingly intractable differences, may take years to materialize. Nevertheless, a discernible pragmatic bent on both sides suggests that India and Pakistan will increasingly opt for the rewards offered by cooperation and trade, even while negotiators labor over the details of a final settlement for Kashmir.

The recent changes in the economic dynamics of both countries, together with a radically altered geopolitical landscape over the past 15 years, make for considerably stronger peace imperatives than before, with potential gains from success larger than ever. To the extent that it's this recognition that underlies the current rapprochement, the chances of success would appear better than in previous attempts at peace. From Standard & Poor's Ratings Services

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