Tensions with India will weigh on growth, Moody’s warns Pakistan

Sustained escalation in tensions with India will weigh on Pakistan’s growth and hamper Islamabad’s ongoing fiscal consolidation, setting back that country’s progress in achieving macroeconomic stability, Moody’s Ratings warned on Monday.

Moody’s said the ratings agency’s geopolitical risk assessment for Pakistan and India accounts for persistent tensions, which have sometimes led to limited military responses.

“We assume that flare-ups will occur periodically, as they have throughout the two sovereigns’ post-independence history,” it said, adding that these “will not lead to an outright, broad-based military conflict.”

The agency underscored that Pakistan’s macroeconomic conditions have been improving, with growth gradually rising, inflation declining, and foreign exchange reserves increasing amid continued progress in the IMF program.

Moody’s noted 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.

In India, comparatively, the macroeconomic conditions would be stable, bolstered by moderating but still high levels of growth amid substantial public investment and healthy private consumption, the ratings firm said.

It added that if localized tensions sustainably escalate, the agency does not expect major disruptions to India’s economic activity because India has minimal economic relations with Pakistan–of less than 0.5% of India’s total exports in 2024.

The agency, however, highlighted that higher defense spending could potentially weaken India’s fiscal strength and slow its fiscal consolidation.

Moody’s has assigned India Baa3, the lowest investment-grade rating, indicating moderate credit risk, and a “stable outlook,” suggesting that Moody’s does not expect to change this rating in the near term.

At the same time, Pakistan’s Caa2 rating is a speculative grade, much lower than Baa3, indicating “very high credit risk” and “highly vulnerable to default.”

The “positive” outlook for India means Moody’s sees a possibility of an upgrade if conditions improve, but the risk remains extremely high.

Last week, on 30 April, Pakistani information minister Ataullah Tarar said Islamabad had “credible intelligence” indicating India was planning a military strike against Pakistan in retaliation for the 22 April terror attack on tourists in Jammu and Kashmir.

Following the attack, diplomatic ties between India and Pakistan deteriorated.

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.