Sustained Pakistan-India tensions could derail Islamabad’s economic recovery, warns Moody’s

Moody’s Ratings, previously known as Moody’s Investors Service, has warned that a “sustained escalation in tensions with India would likely weigh on Pakistan’s growth” and hamper Islamabad’s ongoing fiscal consolidation, “setting back Pakistan’s progress in achieving macroeconomic stability”.

The global credit rating agency, in its report Monday, noted that Pakistan’s macroeconomic conditions have been improving, with growth gradually rising, inflation declining, and foreign-exchange reserves increasing amid continued progress in the International Monetary Fund (IMF) programme.

However, it cautioned that “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.”

The statement comes amid a sharp escalation of tensions between the two nuclear-armed neighbours following the 22 April deadly attack by suspected militants on tourists in the Indian-Illegally Occupied Jammu and Kashmir (IIOJK) Pahalgam area.

“Following the attack, India and Pakistan’s diplomatic relations have deteriorated,” said Moody’s.

India suspended the Indus Waters Treaty of 1960, which could severely reduce Pakistan’s water supply. In response, Pakistan suspended the 1972 Simla peace treaty with India, halted bilateral trade and closed its airspace to Indian airlines, it added.

On the other hand, Moody’s noted that macroeconomic conditions in India “would be stable, bolstered by moderating but still high levels of growth amid strong public investment and healthy private consumption”.

“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 (less than 0.5% of India’s total exports in 2024).

“However, higher defence spending would potentially weigh on India’s fiscal strength and slow its fiscal consolidation,” it stated.

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In its report, Moody’s assumed that “flare-ups will occur periodically, as they have throughout the two sovereigns’ post-independence history, but that they will not lead to an outright, broad-based military conflict”.