If India-Pakistan Tensions Escalate into Prolonged Military Conflict, Pakistan’s Economy Could Collapse – Moody’s

If India-Pakistan Tensions Escalate into Prolonged Military Conflict, Pakistan’s Economy Could Collapse – Moody’s

[New Delhi, May 5, 2025]
Credit rating agency Moody’s has warned that following the April 22 terrorist attack in Pahalgam, Jammu and Kashmir, persistent tensions between India and Pakistan could severely damage Pakistan’s economic recovery, disrupt its access to external financing, and delay progress on its ongoing IMF program.

In a sector analysis released on May 5, Moody’s stated that speculation over possible retaliatory strikes by India — after the killing of Indian tourists by suspected Pakistan-based militants — adds to regional instability.

While India (rated Baa3, Stable) remains broadly economically resilient, Pakistan (rated Caa2, Positive) faces significant risk in the event of sustained military tensions, the report said.

Recent security meetings between Indian Prime Minister Narendra Modi and top defense officials have hinted at possible responses. Regional concerns have intensified since Pakistan’s Information Minister issued a warning on April 30 about potential Indian strikes.

Pakistan’s economy had begun to show signs of recovery, supported by modest growth, declining inflation, and consistent IMF support. However, Moody’s cautioned that prolonged military conflict could derail this fragile progress entirely.

"A sustained escalation of tensions could impair Pakistan’s access to external funding and put pressure on its already low foreign exchange reserves," Moody’s noted. These reserves are currently insufficient to cover the country’s upcoming foreign debt repayments.

India’s economy, on the other hand, is relatively insulated from such tensions, due to extremely limited trade with Pakistan — accounting for less than 0.5% of India’s total exports in 2024.

Moody’s added that prolonged tension could increase India’s public expenditure, putting pressure on fiscal deficits, though the country’s overall macroeconomic stability is expected to remain intact.

The agency further noted that while the nuclear-armed neighbors have experienced many military flare-ups since independence, these have rarely escalated into full-scale war. However, this time Moody’s has raised its geopolitical risk assessment to a “high level” due to the threat of localized military conflict.

Following the Pahalgam attack, diplomatic ties between the two nations have already deteriorated, triggering several retaliatory measures. India has suspended the 1960 Indus Waters Treaty, which could significantly impact Pakistan’s water supply. In response, Pakistan has revoked the 1972 Shimla Agreement, closed its airspace to India, and downgraded bilateral relations.