Since coming to power in 2014, Indian Prime Minister Narendra Modi has shown a penchant for using surprise to launch new policies. In 2016, for example, his government announced a sudden replacement of large-denomination bank notes to fight crime and curtail the shadow economy. Modi’s latest shocker came early last month, when his government suddenly announced that the northern state of Jammu and Kashmir would no longer have the special autonomy it has enjoyed since India’s independence from Britain in 1947. Like the cash reform, officials couched the Kashmir initiative as economic policy – as a way to encourage more development in the region. However, its main impact is likely to be political and strategic. Indeed, it even has the potential to eventually prompt a military confrontation between India and Pakistan, pitting two nuclear powers against each other. That complication makes the situation a real “sweater.” Thus, it makes sense to examine the move in greater detail and discuss what it says about the evolving geopolitical environment. As always, we will also discuss the investment implications of the move.

Himalayan Tug-of-War

Lying high in the Himalayan mountains and constituting the northern tip of India, Kashmir is a region of thickly forested peaks, deep, narrow valleys and barren plateaus (see Figure 1). Over the last two millennia, it has been an important center of Buddhism, then Hinduism, and finally Islam. The region was under Muslim rule from 1346 until it was annexed into the Sikh kingdom of the Punjab in 1819. It was later annexed again in 1846 by the Dogra kingdom of Jammu, making it part of an important Hindu-dominated buffer state that Britain used to protect its Indian colony from the Russian and Chinese empires to the north. Following the Indian Rebellion of 1857, Britain took direct control of Kashmir.

In the aftermath of World War II, as the British were dismantling their global empire, they divided their Indian territory into Hindu-dominated India and Muslim-dominated Pakistan. In the process, princely states such as Kashmir were allowed to decide which country they wanted to join. With some restrictions, they could even opt to become independent. The Hindu “maharaja” of Kashmir initially delayed making a decision with the hope of leading an independent country, but his plan was thwarted by the complex social and religious tensions resulting from the history described above. As his Muslim subjects revolted and tried to seize territory, the maharaja turned to New Delhi for help. India agreed to intervene on one important condition: that Kashmir would become part of India.