The war involving Iran is not Pakistan’s war, but a protracted conflict could prove to be the most devastating economic shock in recent memory for the country.
Pakistan’s Economic Vulnerability
Pakistan is particularly exposed to the fallout, not due to geopolitics, but due to its economic realities. The country imports the majority of its fuel and food, relies heavily on remittances from the Gulf region, and currently lacks the financial flexibility to absorb another significant external shock. Pakistan is considered one of the most vulnerable countries globally to the crisis impacting markets.
The timing of this potential shock is particularly unfortunate. Pakistan’s economy is already weakened by four years of stabilization efforts, a historic cost-of-living crisis, and a decline in income that has erased the gains of the previous decade. Past crises have typically been triggered by rising commodity prices, but usually after a period of domestic economic growth.
This time, however, a commodity price shock is occurring whereas Pakistan is already implementing austerity measures. Shocks to an overheated economy can be mitigated by reduced demand, but those hitting an already suppressed economy are far more damaging. Pakistan’s ability to respond is further limited by its low foreign exchange reserves – less than three months of import cover – and a substantial public debt burden, exceeding 70 per cent of GDP.
Potential Economic Consequences
A prolonged regional conflict could swiftly and severely impact Pakistan. Rising prices for oil, gas, and fertiliser would likely trigger a recession by increasing transport and food costs. A slowdown in the Gulf region would negatively affect remittances and external financing, while regional instability would put pressure on the Pakistani rupee and fuel inflation. A scenario with oil prices averaging $100 per barrel could spot growth fall to near zero, the rupee decline by 10-20 per cent, and inflation surge to mid-double digits.
The current IMF program, while necessary to prevent default, is unlikely to be sufficient. The program’s size is limited by Pakistan’s past borrowing, and it is expected to remain contractionary even if commodity prices rise. Fiscal tightening, higher interest rates, and currency depreciation are likely unavoidable, but will exacerbate the economic slowdown and fail to protect the most vulnerable.
Possible Policy Responses
A more effective response would involve targeted fiscal and monetary stimulus for vulnerable households and firms, alongside foreign exchange intervention and temporary import restrictions to stabilize the rupee and control inflation. However, this requires “policy space,” which must be created through reduced wasteful spending, lower debt servicing costs, increased foreign currency inflows, and debt reprofiling.
The issue of debt is critical. Pakistan’s debt burden is now so large that it constrains all aspects of the policy response and hinders investment and growth. The government pays more on interest as a share of its economy than any other developing country, and the second-highest proportion of government revenue on interest payments globally, after Sri Lanka. This leaves limited resources for social spending and investment.
A Require for a New Approach
Pakistan’s current approach – austerity first, growth later, and debt management – has reached its limit. The country needs a new settlement that allows for short-term demand support, smooth structural reforms, currency defense, and protection for the vulnerable. Policymakers should urgently address these issues in ongoing talks with the IMF and in preparation for the Spring Meetings in Washington.
Frequently Asked Questions
What is Pakistan’s current economic situation?
Pakistan’s economy is already weakened by four years of stabilization, a cost-of-living crisis, and a decline in income. It imports most of its fuel and food, relies on remittances, and has limited financial flexibility.
What are the potential consequences of a prolonged conflict involving Iran?
A prolonged conflict could lead to a recession, a decline in the value of the rupee, and a surge in inflation. Growth could fall to near zero, and the rupee could slide by 10-20 per cent.
What is needed to address Pakistan’s economic challenges?
A new approach is needed that creates policy space for short-term support and long-term economic revival, including reduced debt servicing, increased foreign currency inflows, and debt reprofiling.
What steps can Pakistan accept to mitigate the economic fallout from regional instability?
