MUMBAI/SINGAPORE The initial investor reaction to the Mumbai attacks suggests they expect India's traditionally resilient markets to take a bigger hit from this turmoil than from previous episodes in the city's violent history.
With financial and commodity markets shut after gunmen killed 101 people, the only inkling of damage to sentiment came from a rise in India's risk premium on international credit markets and a drop in offshore Indian stock and rupee futures.
The central bank said it would continue auctions to keep cash flowing through interbank lending markets, which seized up after the global financial crisis destroyed Wall Street banks in September.
Mumbai is no stranger to political violence and markets have usually regarded previous bombings and other attacks with a degree of nonchalance. Wednesday's attacks though will put an additional strain on nerves frayed by global financial turmoil and a tide of cash pouring out of Indian assets.
"Everyone is just hoping that it will be one of the short-lived episodes," said ING chief Asian economist Tim Condon.
"People have seen this before although this is on an order of magnitude worse than what we have seen. That makes the usual comfortable assumption less comfortable, this Pakistanisation of Indian financial markets," he said.
The capital markets regulator said the Bombay Stock Exchange and National Stock Exchange will be closed on Thursday as security forces battled militants who held hostages in two luxury Mumbai hotels.
Coming at a time when foreigners have been heavy sellers of Indian assets, the attacks raised fears of a steeper fall in the rupee and a further blow to market confidence.
"Clearly, it will be negative for the sentiment toward India at this point of time, the time when the world is already looking to be highly uncertain in term of its growth prospects," said Joseph Tan, chief Asian economist at Credit Suisse in Singapore.
"When the equity market actually opens, it could probably be opening down as opposed to the rest of Asia."
As traffic ground to a halt in south Mumbai, where the central bank and several financial institutions are located, it appeared the earliest indications of how deep those concerns run would be known only on Friday.
Trading in offshore rupee forwards was thin but suggested the rupee could drop 1.6 percent within a month, more bearish than Wednesday's pricing of a 0.7 percent depreciation.
The risk premium for top Indian lender State Bank of India rose. The state-owned bank is a proxy in the debt market for the government, which has no sovereign bonds outstanding.
Credit default swaps, which are insurance-like contracts, on the bank's five year bonds widened 20 basis points to 440 basis points after the attacks.
Indian stock index futures fell 4 percent in Singapore trade at their weakest, pointing to a likely steep fall in domestic shares.
On Wednesday, the 50-share NSE index gained 3.7 percent. India's main 30-share BSE index ended up 3.8 percent. The rupee ended trading at 49.48 per dollar.
"As the situation calms down, these attacks might be viewed as an isolated event," said Mumbai-based Amit Khurana, head of equities at the Indian unit of British broker Collins Stewart.
When suburban train bombings killed 180 people in Mumbai in 2006, the rupee barely blipped while the Bombay stock index fell 1.8 percent but then rallied.
There have been four bombings prior to Wednesday's attack this year.
The stock index is already down 55 percent this year -- Asia's fourth worst performer -- after having seen $13.5 billion of portfolio outflows from a market with a capitalization of $266 billion.
The rupee figures among the weakest currencies in Asia this year alongside the Indonesian rupiah and Korean won, having dropped 20 percent against the dollar owing to capital outflows and a withdrawal of foreign credit lines from riskier markets.
"This means that capital outflows will have a greater impact than they did in the past, though history suggests that any reaction to terrorist attacks in Mumbai will only be temporary," Nikhilesh Bhattacharya, an economist with Moody's Economy, said in a note.
Mark Matthews, chief Asian strategist at Merrill Lynch, said this was also the time analysts were downgrading their forecasts for Indian corporate earnings rather dramatically.
"That will continue to be a drag on the market because Indian analysts are behind the curve on earnings relative to the rest of Asia," Matthews said.
Slowing growth and uncertainty about upcoming general elections in 2009 would also weigh down the market, at least until March, he reckons. Merrill predicts the index price-earnings ratio will drop to 9.1 in 2009 from 10.1 now.
Currency analysts expect the rupee will weaken sharply when it opens for trading on Friday, but they also suspect any weakness will be knee-jerk and fleeting and that the central bank will jump to its defense as it always has in volatile spells.
"Such terrorist attacks do not have a lasting impact on the market -- I don't think it will have a lasting impact on India," said Credit Suisse's Tan.