Share markets have reacted favourably to reports that Pakistani backed forces in Indian-administered Kashmir are continuing their withdrawal.

Both Bombay and Karachi stock markets gained 5%, before some profit taking on Tuesday. But how has the fighting in Kargil affected the long term economic prospects of both countries?

A broker trading on the Bombay Stock Exchange

In India, the markets have reacted positively to the news that fighting in the Kargil area could be drawing to a close.

The rupee strengthened against the dollar, while rumours persisted that the country's equity market could soon hit an all-time high.

Analysts say the upturn in India's economy is reflected in better industrial output figures in comparison to last year. India's Gross Domestic Product (GDP) is up by nearly 8.5% in the first quarter of the current fiscal year compared with the same time last year.

Cost of conflict

Yet many financial analysts predict that the economic optimism will not last long. One of the key reasons for this is the cost of the fighting in Kargil, which is estimated to have been between $2-6m a day.

This extra defence spending is expected to add to the country's fiscal deficit. That means less money is likely to be spent on capital projects such as poverty alleviation and irrigation schemes.

A cobbler returns to work in Kargil

However, the Indian finance minister, Yashwant Sinha, has insisted that the conflict will not seriously affect the economy, arguing that the impact of the fighting would be kept within manageable limits.

Economists point out that Mr Sinha is working on the assumption that there will be enough investment and consumption in India to offset the costs of the fighting.

Pakistan's worry

Although there are few concrete figures that show how much the Kargil conflict has cost Pakistan, analysts say the optimism on the markets is unlikely to last.

They say the fighting is almost certain to deter foreign investment, which is so crucial if the country's finances are to improve.

The fighting means that Pakistan, like India, will need to spend more on defence. If Islamabad is to do that, it needs to raise more money.

On Monday, the country's main tax agency - the Central Board of Revenue - launched a drive to get more people to pay their taxes. It is estimated that less than one per cent actually pay income tax.

Yet even if the fighting has resulted in tighter economic conditions for India and Pakistan, it has to be remembered that the economies of both countries have in the past proved to be extraordinarily resilient.

This time last year, India and Pakistan were counting the cost of their respective nuclear tests. The United States and Japan had imposed sanctions and some analysts were predicting that both would go into decline.