The thaw in relations between nuclear-armed rivals India and Pakistan has sparked a market rally and is expected to boost foreign investment in a region that has lagged faster-growing neighbour China.

Indian stocks, which were dawdling at six-month lows, have now risen for six straight days after moves to normalise relations began last week.

Pakistani stocks have bounced to record highs after New Delhi's promise to restore diplomatic ties with Islamabad raised hopes the two sides could hold summit talks this year, the first in two years.

"It would remove the risk premium that is attached to investments in the region," said V Anantha Nageswaran, Singapore-based regional head of investment consulting at Credit Suisse Financial Services.

"Besides improved stock valuations, we could see FDI (foreign direct investment) flows into areas like outsourcing."

India has an annual FDI target of $10 billion but has only managed about $3.0-$4.0 billion in recent years, compared with the $52.7 billion that flowed last year to China.

A growing number of multinationals are relocating services like payroll management, stock analysis, accounting and claims processing to India where salaries of English-speaking IT workers may be as little as 10 per cent of those in London or New York.

Last month J P Morgan Chase said it would hire 40 junior stock analysts and other researchers in its Mumbai office this year while Deutsche Bank AG has reportedly contracted Irevna Limited, a London-based consultancy that specialises in outsourcing to India.

That trend could gain momentum. A 10-month military stand-off last year between the two countries after an attack on the Indian Parliament in December 2001, had threatened to choke India's prospects in this increasingly global business.

IT consultant IDC has forecast the global outsourcing industry will grow to $87 billion by 2005 from $68 billion in 2002 and India hopes to take a growing chunk of that.

Economists said the peace moves should also benefit Pakistan's economy as trade with its bigger, richer neighbour begins to open up after years of restrictions.

Trade boost for Pakistan

The latest sign of a thaw came when Islamabad said on Tuesday it would restore severed transport links which, coupled with difficulties obtaining visas, have made it hard to trade across their common border.

"Both consumers and industries in Pakistan will benefit from cheaper Indian imports," said Akbar Zaidi, an independent Karachi-based economist. "They will also have access to India's massive market. Trade with India is a win-win situation."

Official data shows bilateral trade at around $204 million in the year to the end of March 2002, but analysts say annual trade could be $3 billion including trade via other countries and smuggling.

Analysts know the road ahead will be bumpy.

An Indian official's comment on Wednesday that Pakistan's decision to restore travel and sporting ties as a prelude to peace talks was inadequate reinforced that cautious view.

"We need to see concrete evidence that progress has been made unlike in the past," said Sanjeev Sanyal, regional economist with Deutsche Bank. "Key signs of peace would be a visible decline in violence in Kashmir and a solution to the Kashmir issue which is acceptable to both sides."

Foreign portfolio investors have some $16 billion in Indian assets, with foreign ownership accounting for about 13 per cent of the stock market's capitalisation of about $120 billion.