Escalating tensions threaten Pakistan’s economy, forex reserves; India largely immune: Moody's

Sustained escalation of tensions between India and Pakistan is likely to weigh on Pakistan's economic growth and pressure its already fragile foreign exchange reserves, while India is expected to remain relatively unscathed due to minimal economic linkages, Moody’s Ratings said on Monday.

In a commentary titled “Escalating Pakistan-India tensions would weigh on Pakistan's growth,” the ratings agency warned that renewed hostilities could hamper Islamabad’s fiscal consolidation efforts and progress toward macroeconomic stability.

India, on the other hand, would likely avoid major economic disruption given that exports to Pakistan accounted for less than 0.5% of its total exports in 2024.

"Sustained escalation in tensions with India would likely weigh on Pakistan's growth and hamper the government's ongoing fiscal consolidation, setting back Pakistan's progress in achieving macroeconomic stability," Moody's said.

"A persistent increase in tensions could also impair Pakistan's access to external financing and pressure its foreign-exchange reserves, which remain well below what is required to meet its external debt payment needs for the next few years," it added.

The agency’s comments come in the wake of a deadly terrorist attack in Jammu & Kashmir’s Pahalgam region on April 22, which killed 26 people. India has identified five terrorists, including three Pakistani nationals, behind the massacre and has since imposed a series of punitive measures, including suspension of the 1960 Indus Waters Treaty and a ban on direct or indirect imports from Pakistan.

In response, Islamabad suspended the 1972 Simla Agreement, halted bilateral trade, and banned Indian flag carriers from accessing Pakistani ports. It also barred Pakistani vessels from docking in Indian ports.

Moody’s maintains a ‘Caa2’ rating on Pakistan, indicating high credit risk, while India is rated at ‘Baa3’, the lowest investment-grade rating.

India’s exports to Pakistan stood at $447.65 million during April–January 2024-25, while imports were a negligible $0.42 million, limited to niche items like figs, herbs, certain chemicals, and Himalayan pink salt.

"In a scenario of sustained escalation in localised tensions, we do not expect major disruptions to India's economic activity because it has minimal economic relations with Pakistan. However, higher defence spending would potentially weigh on India's fiscal strength and slow its fiscal consolidation," Moody's said.

Although Pakistan’s economy has shown signs of recovery, Moody’s said the risk of disruption looms large. The IMF’s Executive Board is scheduled to meet Pakistani officials on May 9 to discuss a $1.3 billion funding package under a climate resilience loan programme and to review an ongoing $7 billion bailout package.

India may urge global financial institutions to reassess funding to Pakistan in light of the recent attack, reported PTI, citing people familiar with the matter.