Tensions between Pakistan and Iran impact markets, raise economic concerns

With a crippling financial crisis characterized by high inflation, substantial fiscal and current account deficits, and an economy valued at $350 billion, Pakistan faces a delicate economic landscape.

Geopolitical tensions between Pakistan and neighbouring Iran have reverberated through Pakistan’s financial markets, sparking concerns about the country’s struggling economy. The escalation unfolded on Thursday when Pakistan conducted strikes inside Iran, targeting separatist Baloch militants, just two days after Tehran reported attacks on bases of another group within Pakistani territory.

As Pakistan approaches a scheduled election on Feb. 8, these developments add another layer of complexity to the nation’s already precarious economic situation. With a crippling financial crisis characterized by high inflation, substantial fiscal and current account deficits, and an economy valued at $350 billion, Pakistan faces a delicate economic landscape.

An International Monetary Fund (IMF) loan program, agreed upon in July and amounting to $3 billion, provided temporary relief and prevented Pakistan from sliding into sovereign debt default. However, this nine-month standby arrangement is set to expire this spring, raising concerns about the country’s ability to navigate its economic challenges.

The impact of the geopolitical tensions is evident in the financial markets. Pakistan’s international bonds initially experienced a decline of as much as 1.3 cents in early trade, though some recovered losses and shorter-dated bonds were down 0.4 cents. Bonds maturing in 2031 and beyond traded between 60.9-64.1 cents, well below the critical 70-cent threshold where debt is considered distressed.

The benchmark share index also felt the effects, dropping by as much as 1.6% before recovering slightly to close 0.57% lower. These market movements reflect the uncertainty and investor apprehension regarding the evolving situation between Pakistan and Iran.

Economic ties with Iran, though not massive, are crucial for Pakistan, especially in supplying its westernmost regions, such as Balochistan, with essential commodities. The interruption of trade routes and the potential disruption of bilateral trade, valued at over $2 billion, could have immediate consequences, leading to shortages in Pakistan and a notable decrease in trade volume.

Aneel Salman, Chair of Economic Security at the Islamabad Policy Research Institute, emphasized the significance of this bilateral trade, particularly for regions like Balochistan, where local economies heavily depend on trade with Iran for agricultural products and petrochemicals.

Moreover, long-term collaborative projects, such as the Pakistan-Iran gas pipeline, known as the Peace Pipeline, may face setbacks. Already delayed, the pipeline aims to transport natural gas from Iran to Pakistan and potentially India. The recent escalation of tensions adds further uncertainty and potential funding challenges to the project.

While some analysts believe that the current episode may not lead to a more serious escalation, it unfolds as Pakistan is actively seeking to improve relations with the United States. The evolving geopolitical situation adds complexity to Pakistan’s diplomatic efforts and underscores the interconnected nature of economic and geopolitical challenges faced by the nation. As the tensions persist, the impact on both the short-term economic outlook and long-term collaborative initiatives remains uncertain.