Attacks may be stern test for shaky India markets

By Narayanan Somasundaram and Vidya Ranganathan

MUMBAI/SINGAPORE (Reuters) - 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.