SCENARIOS: Potential outcomes in Pakistan's war with Taliban

TALIBAN MAKES DRAMATIC TERRITORIAL GAINS

If the Taliban was able to make significant inroads into the key provinces of Punjab and Sindh, the implications would be highly bearish for local stocks and the rupee, and global markets could be rattled by the rising risk that Pakistan could implode.

But the chances of this happening are minimal.

The Taliban remains a loose coalition of disparate militia groups, able to muster at most up to 10,000 fighters who are expert at insurgency warfare in their tribal strongholds but would be quickly crushed in a conventional war with the army.

Their popular support in Punjab and Sindh is minimal.

"We may see pockets of Talibanization -- parts of Karachi are vulnerable," said Chietigj Bajpaee at Control Risks. "But the whole country falling under Taliban rule is an exaggeration."

MILITARY TAKES POWER AGAIN

Given the increased popular resentment that forced former President Pervez Musharraf to relinquish power, analysts say the Pakistani military has little appetite for another coup.

But if the situation deteriorates badly, that could change.

"Over the six months or a year, another military intervention is unlikely, given the backlash against the Musharraf government," Bajpaee said. "But if there is seen to be significant political gridlock, and the government is not seen to be taking action, then there is a possibility."

Analysts say that given the unpopularity of President Asif Ali Zardari, a coup would be positive for markets.

"Given Pakistan's unfortunate history of coups, it would be a very unwise person indeed whoever ruled out a coup in Pakistan," said Nomura senior political analyst Alastair Newton. "But I don't see that as a bad thing in terms of market perceptions."

STRONGER GOVERNMENT EMERGES

Zardari's approval ratings have tanked and opposition leader Nawaz Sharif enjoys far higher popularity -- a poll this week gave him 75 percent approval versus Zardari's 19 percent.

Sharif appeals to a religious conservative constituency, and was a "bete noire for Washington" in the past, Newton said. But there are signs that the United States, exasperated by Zardari, is starting to make overtures to Sharif.

Analysts say that if a way can be found to bring Sharif and his supporters back into the government fold, either through an accommodation with Zardari or by removing him probably with the army's help, this would be positive for stability and markets.

(Editing by Sugita Katyal)