Pakistan's Economy Faces Risk Amid Escalating Tensions, India Relatively Immune: Moody's

Moody's Ratings assessed on Monday that increased India-Pakistan tensions would harm Pakistan's economy by straining its foreign exchange reserves and hindering growth, whereas India's economy is expected to be relatively immune.

In their commentary, 'Escalating Pakistan-India tensions would weigh on Pakistan's growth,' Moody's explained that India's economic activity is not expected to face major disruptions due to its small trade exposure to Pakistan, accounting for less than 0.5% of India's total exports in 2024.

Following the April 22 killing of 26 tourists by terrorists in Pahalgam, Jammu & Kashmir, India has identified five perpetrators, including three Pakistanis, and promised retaliation.

"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.

In recent period, Pakistan's economy has showing signs of improvement with gradual growth, relatively lower inflation, and increasing foreign-exchange reserves, supported by ongoing progress in its IMF program.

"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," Moody's said.

India is reportedly planning to ask global agencies like the IMF to review their financial support to Pakistan, sources say. Sources indicate India will request multilateral bodies, including the IMF, to re-evaluate funds and loans given to Pakistan.

Moody's indicated that India's macroeconomic situation is expected to be stable, underpinned by strong public investment and healthy private consumption, which are contributing to a growth rate that is moderating but remains high.  

"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.

Moody's explained that their assessment of geopolitical risk for Pakistan and India takes into account the continuous tensions between them, which have sometimes escalated into limited military responses.

"We assume that flare-ups will occur periodically, as they have (been) throughout the two sovereigns post-independence..., but...it will not lead to an outright, broad-based military conflict," it added.

Moody's 'Caa2' rating indicates that debt from Pakistan is of low quality and carries a very high risk of default.

Moody's rates India at 'Baa3', which is the lowest investment-grade rating.

Citing 'cross-border linkages' to the April 22 attack, India has promised severe punishment to those involved in the strike.

Following the deadly terror attack, India and Pakistan's diplomatic relations have deteriorated. India suspended the Indus Waters Treaty of 1960, which could severely reduce Pakistan's water supply, shut down the only operational land border crossing at Attari and downgraded diplomatic ties.

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

Last week, India imposed a ban on the import of goods originating from or passing through Pakistan, halted the exchange of mail and parcels, and prohibited the entry of Pakistani ships at Indian ports in fresh punitive measures against Islamabad.

Many global powers, including the US and European Union, have called on both India and Pakistan to de-escalate tensions while unequivocally condemning the terror strike.

India's exports to Pakistan in April-January 2024-25 stood at $447.65 million, while imports were meagre $0.42 million. These imports were limited to niche items like figs ($78,000), Basil and Rosemary herbs ($18,856), certain chemicals, and Himalayan pink salt. The imports were $2.88 million in 2023-24.

(With inputs from PTI)