KARACHI (Reuters) - An outburst of ethnic violence in Pakistan’s commercial capital Karachi in recent days killed at least 27 people, as tension between the dominant Mohajir community and ethnic Pashtuns from the northwest boiled over.

The violence in the city of more than 16 million people reflects tension across the country as the mostly Pashtun Pakistani Taliban step up attacks from their strongholds in the northwest on the Afghan border.

The clashes will add to concern nuclear-armed Pakistan is becoming more unstable as President Asif Ali Zardari and Afghanistan President Hamid Karzai prepare to meet U.S. President Barack Obama in Washington on Wednesday.

Karachi is a major entry point for military supplies shipped on by land to Afghanistan for the U.S.- and NATO-led anti-insurgency effort.

The Karachi violence has also dented the confidence of already nervous investors, and analysts say any further deterioration in city security could lead to a sharp fall in stocks and hurt business in general.

The Karachi Stock Exchange benchmark 100-share index lost some ground last week because of the violence, and was down more than one percent, or by about 90 points, to 7,112 at 9:25 a.m. British time on Monday.

WHO LIVES IN KARACHI?

Karachi, Pakistan’s biggest city and capital of the southern Sindh province, has long been a tinder box. Serious violence between rival factions was common in the 1990s.

Mohajirs, the descendents of Urdu-speaking people who migrated from India after the creation of Pakistan in 1947, are the biggest community and dominate the city’s administration.

Karachi is also home to the largest concentration of Pashtuns outside North West Frontier Province. According to some estimates, more than 3.5 million Pashtuns live in the city.

The central bank and main stock exchange are also in Karachi which has the country’s main industrial base and contributes the most in taxes to the national kitty.

The city also has the country’s two main ports and most foreign companies investing in Pakistan have offices there.

HAS KARACHI EXPERIENCED VIOLENCE BEFORE?

Karachi has a long history of ethnic, religious and sectarian violence. It was a main target of al Qaeda-linked militants after the September 11, 2001, attacks on the United States when Pakistan joined the U.S.-led campaign against terrorism, and the city experienced several attacks on foreigners. However, things have been relatively calm on that front in recent years as militants focussed attacks on cities in the north and across the northwest.

WHAT IS HAPPENING?

Mohajirs in Karachi have become increasingly suspicious of a Pashtun community that has strong Islamist sympathies following the surge in militancy in the northwest.

The Muttahida Qaumi Movement (MQM), which represents Mohajirs and has been the dominant political force in Karachi for years, has raised fears of “Talibanisation” of Karachi. The party says Pakistani Taliban and members of allied militant groups have infiltrated Pashtun-dominated districts of the city.

The MQM, which controls the city government and is also part of a provincial coalition government led by President Zardari’s Pakistan People’s Party, also says Pashtuns are involved in crime, such as land grabbing. The MOM says the violence last week was a result of authorities’ anti-crime efforts.

Some analysts say city politics rather than a real Taliban threat are at the root of the tension. The MQM fears changing city demographics, in particular the arrival of more Pashtuns, will weaken its power base.

The MOM’s main opposition in Karachi is the secular, Pashtun-dominated Awami National Party (ANP), which runs the government in North West Frontier Province and managed to win two seats in the Sindh provincial assembly in the last election.

The ANP is a member of the federal coalition so the tension is between two provincial-based, central government allies. As such, the trouble should not undermine the federal government.

WHAT’S AT STAKE?

While stock investors are getting used to trouble in the northwest, violence in Karachi has a more immediate market impact.

The rupee, which has weakened 1.75 percent against the dollar this year after losing 22.12 percent in 2008, was steady last week but prolonged violence would hurt economic activity and disrupt exports, putting more pressure on the currency.

Pashtuns control most of Karachi’s transport network which means they could paralyse the city and its ports if they stopped work in response to violence.