Weekly
Geopolitical Report
By Bill O’Grady
July 19, 2010
Due to business travel, the next report will be published August 2nd.
The Geopolitics of India
India’s economy has become one of the more
important in the world, part of the so-called
“BRIC” nations (Brazil, Russia, India and
China). Although investors tend to lump these
emerging markets together, they have
significantly different histories and
geopolitical backgrounds. In this week’s
report, we examine the geopolitics of India.
We will discuss the geography of the Asian
subcontinent, briefly comment on the history
of the region and examine the current
geopolitical situation in light of events over
the past decade. As always, we will comment
on the ramifications of India’s geopolitics on
the financial markets.
The Geography of the Asian Subcontinent
This map shows most of the Asian
subcontinent with a focus on India. The key
geographic features of India and the
surrounding states is that the region is
effectively an island with two major rivers.
The Ganges River, originating in the
Himalayas, runs west to east across the
northern tier of India. The Indus River, which
begins in the same mountain range, runs south
into the Arabian Sea. The Himalayas separate
the subcontinent from China and the Middle
East. Finally, dense jungles isolate the region
from Southeast Asia.
Some commentators have noted that Europe
and the Asian subcontinent have similar
geographies. Europe juts into an ocean and is
cut off from Asia and Africa by the Ural
Mountains and the Black and Mediterranean
Seas. However, there is a significant and
illustrative difference. Europe has major
internal mountain ranges that have isolated
various peoples. These groups have, over
time, developed into nation states that
consider themselves separate ethnic groups.
Thus, Europe, despite nearly 60 years of
efforts by policy elites to create a “state of
Europe” has failed to overcome regional
nationalism.
In India, the natural internal boundaries were
never strong enough to undermine an Indian
identity. There are different cultures on the
subcontinent, including Punjabis, Gujaratis,
Marathis, Tamils, etc. These groups increase
the difficulty in governing India. However,
these groups have not, in general, developed
into separatist movements.
(Source: University of Texas)
Weekly Geopolitical Report – July 19, 2010
In general, domestic or foreign powers that
have dominated the Indian subcontinent
have accomplished three goals. First, they
have gained control of the Ganges River
Basin. The river plains are very fertile and
control of this river valley is critical to the
economy of the region. Second, successful
powers have expanded their influence to as
much of the region as possible. Since there
are few insurmountable internal boundaries,
it is important to expand one’s influence into
every region that is populated. Third, they
have held the Indus river valley as a bulwark
against Middle East invaders.
When a power has managed these three
goals, it usually shifts its focus to
developing a navy to project power.
Overall, though, domestic or foreign powers
that have controlled the Indian subcontinent
have been content to govern that area. They
have not used it as a springboard to gain
territory in the Middle East, China or
Southeast Asia.
A short history of the Indian subcontinent
Although there is a clear nationalist identity
to India, there is also enough ethnic diversity
to undermine central control. Unlike
Europe, which has natural geographic
boundaries, the openness of the subcontinent
allows peoples to move around in the region.
The variety of ethnic groups in India made it
difficult to develop strong, centralized
governments. Thus, the region became
vulnerable to outside invaders. There are
generally two routes for outsider invaders.
First, there is the mountain passes through
modern day Afghanistan. The second is the
oceans.
Islamic rulers, who came from overland
routes, dominated the subcontinent from the
11th to the 19th centuries. The Mughals were
probably the most important and controlled
India for nearly three centuries, from 1526
Page 2
to 1803. What is interesting about these
foreign Islamic powers is that they were
generally willing to allow most of India to
remain Hindu. Only the far eastern and
western regions became majority Islamic.
What these rulers found was the Hindus
were willing to accommodate these outside
powers, which permitted the local
population to live in peace and allowed the
occupier to exploit the riches of the region.
The British East India Company, arriving by
sea, established trading and factory
operations in India in 1612 with the
permission of the Mughal rulers. Over time,
the company expanded its control over more
territory as the Mughal Empire deteriorated.
By the 1850s, the company was the defacto
ruler of India. India became an official
colony of the British Empire in 1858 and
controlled India until its independence in
1947. The British ruled the Indian
subcontinent by manipulating local ethnic
groups to prevent them from unifying
against the colonists.
India became the “crown jewel” of the
British Empire. The Indian economy
generated raw materials and other
manufactured goods for England. To
secure the colony, the British established
other colonies to support supply lines to
India. The Suez Canal, the port of Aden and
Singapore were essentially created to
support and secure India.
After the Second World War, Indian elites
pressed for independence. In the aftermath
of the war, the British economy was in dire
shape. Due to funding constraints, the
Royal Navy was unable to maintain its
global reach; that role had been ceded to the
U.S. However, the U.S. had no interest in
helping Britain maintain its empire. This
factor increased Britain’s cost of
maintaining India as a colony.
Weekly Geopolitical Report – July 19, 2010
In addition, increasing civil unrest (best
remembered by the civil disobedience
campaign by Mahatma Gandhi) increased
security costs. The British resigned
themselves to losing India and, in effect, the
empire. On August 15, 1947, India was
portioned into two states, India and Pakistan
(East and West), which were both declared
independent. Pakistan was majority Muslim
while India was majority Hindu.
The Geopolitics of India
The creation of India and Pakistan created
significant geopolitical problems that remain
unresolved. As noted in the above section
on geography, successful rulers of the Indian
subcontinent control both the Ganges and
Indus river valleys. In the partition,
Pakistan controls the Indus and Bangladesh
(which ceded from Pakistan in 1971)
controls the Ganges River delta. Since the
“natural” geopolitical goal is to control these
rivers, there have been persistent tensions
between Pakistan, Bangladesh and India.
These problems will likely persist although
the magnitude of tensions waxes and wanes.
To manage this geopolitical problem, India
has relied on various alliances with other
nations. For most of the Cold War, India
was allied with the Soviets. This was a
nearly perfect relationship for India. The
communist state could provide aid and
military equipment but there was enough
physical distance between them so as to
prevent Russian dominance.
This relationship with the Soviets not only
gave aid to India, it acted as a counterweight
to the U.S. India feared that the U.S. would
simply replace Britain as a domineering
power. After all, the U.S. had a navy with
global reach and, after the Second World
War, appeared to be filling the vacuum that
the European powers were creating due to
Page 3
decolonization. The Soviet Union could act
as a foil to any U.S. plans.
Unfortunately, India’s alliance with Russia
was of great concern to the U.S. The United
States feared that the Soviets would
establish naval bases in India and use the
country as a base to dominate the Indian
Ocean. To counter this possibility, the U.S.
befriended Pakistan. The Pakistanis offered
two major advantages to the U.S. First,
being an Islamic state, it acted as a
counterweight to Nasser’s Egypt and against
leftist Arab governments. Second, it
provided a base for land incursions into
India if necessary. Pakistan relished the
opportunity to have an alliance with the U.S.
as a way to thwart Indian designs on the
Indus River valley.
Of course, in the Cold War foreign policy
chess game, the Soviet’s counter to the U.S.
alliance with Pakistan was to dominate
Afghanistan. The Soviet relationship with
Afghanistan was supported by India, who
was interested in encircling Pakistan.
India’s relationship with China is
complicated. Although China and India
share a border, India is really isolated from
China by the Himalayas. China and India
did have a border war in 1962 which ended
inconclusively (much of the conflict
occurred at very high altitudes, above
15,000 feet, which made fighting difficult).
Although China and India were both allied
with the Soviet Union, China feared that
India and the Soviets would ally against
them to gain control of Chinese territory.
China is also deathly afraid of an
independent Tibet, because it fears it would
be dominated by India which would use
Tibet as a springboard to attack it. Thus,
China has tended to support Pakistan during
the Cold War which is inconsistent with
international communism but makes sense
Weekly Geopolitical Report – July 19, 2010
geopolitically. China’s relationship with the
Soviet Union had become strained during
the 1960s (which opened the door for
Nixon’s visit to China in 1972) and so
supporting Pakistan weakened India and
Afghanistan, both Soviet allies. India, due
to its ties to the Soviets, also supported
Afghanistan; this worked to surround
Pakistan.
The Soviet invasion of Afghanistan further
muddied the geopolitical waters. Pakistan
and the U.S. worked to undermine the
communist regime in Afghanistan; these
efforts were ultimately successful. For
India, this was an adverse outcome.
Pakistan now had a friendly government on
its western border and its ally, the Soviet
Union, suffered a major defeat. India was,
to some extent, set adrift due to its loss of a
major ally.
This situation experienced a major reversal
with the al Qaeda attacks on New York and
Washington, D.C. in 2001. Pakistan
suddenly found itself under strong pressure
from the U.S. to force the Taliban, who was
ruling Afghanistan with Pakistani support, to
turn over al Qaeda’s leadership to the U.S.
Pakistan did support U.S. efforts to oust the
Taliban after they refused to hand over
Osama bin Laden and his supporters.
However, Pakistan has been less than
enthusiastic about supporting U.S. efforts
against the Taliban. Pakistan views the
Afghan Taliban as allies and does not want
to see a government in Afghanistan that is
opposed to Pakistani interests or supportive
of India.
U.S. frustration with Pakistan has led to
improved relations with India. The U.S. has
moved to improve trade ties and has
supported India’s nuclear program.
Improved relations with India have put
Pakistan in a difficult position. Essentially,
Page 4
Pakistan runs the risk of losing the U.S. as
an ally and, even worse, seeing its former
patron become more supportive of India.
Geopolitically, the tensions seen in the
Asian subcontinent are mostly due to the
fact that India needs to control Pakistan and
Bangladesh to stabilize and fully exploit the
natural and human resources of the region.
Pakistan and Bangladesh want to preserve
their Islamic identity and are resisting this
goal. We would expect this region to
remain unsettled until the natural
geopolitical tendencies are resolved.
Ramifications
Overall, the Asian subcontinent is a global
“hot spot.” India, Pakistan and Bangladesh
will consistently try to undermine the
sovereignty of the others to fulfill the
geopolitical tendencies to the region. For
outside powers, there is an incentive to try to
influence the region due to its economic
potential. At the same time, the problems
caused by the divisions in the region are
generally intractable. We don’t expect overt
hostilities to break out in the foreseeable
future, but we do expect the geopolitical
aims of the nations in the region to
persistently frustrate U.S. efforts to stabilize
the area and prevent it from supporting
global terrorist movements.
Foreign investors are especially drawn to the
economic dynamism that is represented by
India. However, it is important to remember
that India is in a geopolitically unstable
region that could undermine its ability to
develop as an economic powerhouse. As
mentioned above, we don’t expect a “hot
war” to develop in the immediate future but
the instability imbedded in the situation on
the Asian subcontinent is a risk that a
prudent investor will account for in his
foreign allocation.
Weekly Geopolitical Report – July 19, 2010
Page 5
Bill O’Grady
July 19, 2010
This report was prepared by Bill O’Grady of Confluence Investment Management LLC and reflects the current opinion of the
author. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements
expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any
security.
Confluence Investment Management LLC
Confluence Investment Management LLC is an independent, SEC Registered Investment Advisor located
e firm provides professional portfolio management and advisory services to
in St. Louis, Missouri. The
institutional and individual clients. Confluence’s investment philosophy is based upon independent,
fundamental research that integrates the firm’s evaluation of market cycles, macroeconomics and
geopolitical analysis with a value-driven, fundamental company-specific approach. The firm’s portfolio
management philosophy begins by assessing risk, and follows through by positioning client portfolios to
achieve stated income and growth objectives. The Confluence team is comprised of experienced
investment professionals who are dedicated to an exceptional level of client service and communication.