FACTBOX-Five political risks to watch in Pakistan

ISLAMABAD, Nov 3 (Reuters) - Pakistan's military has launched an offensive in the key militant stronghold of South Waziristan, while al Qaeda-linked insurgents have struck back with a series of bomb attacks in major cities. Following is a summary of key Pakistan risks to watch: INTERNAL SECURITY Large swathes of Pakistan remain outside government control, run by the Taliban and tribal leaders. This year's military campaign to roll back Taliban territorial gains saw a number of successes, and the killing of Baitullah Mehsud in a drone attack was a major Taliban setback. But insurgents have shown they can launch major attacks in key urban, industrial and commercial centres with relative impunity, which has significant implications for investment and growth. Key issues to watch: -- Ability of militants to launch attacks. The Oct. 10 assault on the army's headquarters showed the continued ability of Taliban militants to attack key targets with relative impunity. Can the military improve security? -- Safety of Pakistan's nuclear arsenal. What does Pakistan's poor record of preventing audacious attacks mean for nuclear security? Could militants steal nuclear material, or are there adequate safeguards in place? -- Results of the South Waziristan offensive. Many analysts are sceptical the military can make a long-term impact on the ability of militants to use the lawless region as a base. EXTERNAL SECURITY Following a serious deterioration due to the Mumbai attacks last November, relations with India have stabilised. The United States has been trying with some success to persuade Pakistan to focus on the Taliban threat within its borders rather than the perceived external threat from India. But with many groups in Pakistan still sworn to launch more attacks in India, particularly over disputed Kashmir, there is a continual risk of another sudden chill in relations. With two nuclear-armed powers facing off along an extensive shared border, there also remains the risk a military accident or misunderstanding is quickly magnified into major conflict. Key issues to watch: -- Progress on resuming substantive talks. The meeting of foreign ministers in New York did not lead to any announcement of renewed wide-ranging peace talks, with India still reluctant to make any concessions until more is done in Pakistan to deal with those behind the Mumbai attacks. But any sign of rapprochement will be greeted positively by investors. GOVERNMENT EFFECTIVENESS The government has limited control over the military, and has also been undermined in recent tussles with the judiciary. It has proven relatively ineffective in making headway on corruption or reforming the economy. Problems in formulating and implementing policy will continue to act as a major drag on investment. Key issues to watch: -- Changes in political balance of power. Markets will be watching manoeuvring by opposition parties and the military to gauge the possibility of a challenge to the government. Most analysts expect the government to remain in power for now, but distracted from reforms because of its focus on survival. ECONOMIC REFORM AND INVESTMENT IN INFRASTRUCTURE Pakistan has traditionally had legislation that favoured openness to foreign investment, and given the government's need to promote growth, there is the chance of more economic reforms, although these may not be enough to reverse the impact of chronic insecurity and corruption. Investment is desperately needed in infrastructure and energy -- power shortages have badly damaged the economy, particularly in Karachi. Trade is another economic policy focus -- the government banned the private import of wheat this year, and may implement other protectionist measures. Key issues to watch: -- Policy announcements. Markets are awaiting substantive announcements that would show the direction of policy. -- Pressure from the IMF and "friends of Pakistan". Allies pledged $5.7 billion in aid to Pakistan in April, but only a fraction has arrived, with donors wanting more detail on how the money will be used. A $7.6 billion loan from the IMF was agreed last November. Markets will be watching to see if donors are able to force the pace of economic reform. CORRUPTION AND GOVERNANCE Pakistan is perceived as one of the world's most corrupt countries, with rampant bribery, opaque legislation and an unreliable judiciary. The consensus view is that corruption has worsened significantly since the transition from military to civilian rule -- a further deterrent for investors. Key issues to watch: -- Corruption estimates. Investors will be watching to see whether Pakistan rises or falls in corruption perception rankings. (Reporting by Andrew Marshall; Editing by Jerry Norton) Keywords: PAKISTAN RISKS/ ([e-mail]; [phone]; Reuters Messaging: [e-mail]) COPYRIGHT Copyright Thomson Reuters 2009. All rights reserved.

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