Pakistan’s growth prospects dim as conflict with India intensifies

May 05, 2025 (MLN): Pakistan's (Caa2 positive) growth outlook faces new risks as escalating tensions with neighboring India (Baa3 stable) threaten to derail economic progress.

On 30 April, Pakistan's information minister alleged that India was planning an imminent military strike in retaliation for the 22 April deadly attack on tourists in the Indian-administered region of Jammu and Kashmir, carried out by suspected militants, according to MOODY'S ratings.

The aftermath has seen a rapid deterioration in diplomatic ties. India responded by suspending the Indus Waters Treaty of 1960, posing a serious threat to Pakistan's water supply.

In return, Pakistan suspended the 1972 Simla peace treaty, halted bilateral trade, and closed its airspace to Indian airlines.

Sustained escalation could weigh heavily on Pakistan's economic recovery and hinder ongoing fiscal consolidation efforts, potentially reversing progress made in macroeconomic stability.

Although growth has been gradually rising, inflation is declining, and foreign exchange reserves have improved under the IMF programme.

Further instability could limit Pakistan's access to external financing and put additional pressure on its reserves, which are already insufficient to meet near-term external debt obligations.

In contrast, India's macroeconomic conditions are expected to remain stable, supported by moderating yet strong growth, robust public investment, and healthy private consumption.

Given limited economic ties with Pakistan (less than 0.5% of India's exports in 2024), localized tensions are unlikely to significantly impact India's broader economic activity.

However, any increase in defense spending may slow down India's fiscal consolidation and weigh on fiscal strength.

Geopolitical risk assessments for both countries factor in recurring tensions, which have historically led to limited military responses.

While periodic flare-ups are expected, a full-scale military conflict remains unlikely.

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