Economic crossfire: How India-Pakistan tensions are reshaping South Asia’s financial landscape

In the aftermath of the April 22 terrorist attack in Pahalgam, Kashmir, which claimed 26 lives, India and Pakistan find themselves embroiled in a renewed cycle of diplomatic and economic hostilities. India attributes the incident to Pakistan-based militants, leading to escalated political tensions and a series of economic repercussions reverberating across both nations. From banning imports and blocking airspace to halting river water supplies and lobbying international institutions, India has weaponised its economic toolkit — and the fallout is rippling across South Asia.

What’s unfolding now is not just a diplomatic standoff. It’s a new form of warfare — one fought through trade, transport, and finance. While the immediate impacts are already visible, the long-term consequences could permanently reshape the subcontinent’s economic architecture.

India’s economic response commenced on May 2, with the Directorate General of Foreign Trade (DGFT) announcing a complete ban on goods imported from or routed through Pakistan, including via third countries like the UAE. Although bilateral trade has historically been limited — accounting for just 0.06% of India’s total trade — the ban carries symbolic weight and delivers a direct blow to sectors in Pakistan reliant on Indian imports.

India’s exports to Pakistan in FY 2023–24 were valued at $1.18 billion, while imports from Pakistan stood at just $2.88 million. Despite the modest figures, key supply chains — especially for chemicals, food, and medicine — are now disrupted. Indian ships are banned from docking at Pakistani ports, and vice versa, forcing exporters to reroute through costlier third-party ports.

The trade ban hits Pakistan in sectors where it’s already vulnerable. The country imports vital inputs from India, many of which are not easily substitutable in the short term. For instance, Pakistan’s pharmaceutical industry relies heavily on Indian raw materials, with more than 90 per cent of raw materials being imported and only 12 per cent of active pharmaceutical ingredients locally produced. A report by the Institute of Chartered Accountants of Pakistan estimated that the Pakistani pharmaceutical industry has a 50–60 per cent import reliance on India.

Industries like pharmaceuticals and processed food are likely to feel immediate pain, while the auto and chemical sectors could face medium-term disruptions due to supply chain breakdowns. Pakistan’s economy, already grappling with inflation, will now face additional pressure from these import shortages.

In a tit-for-tat move, India shut its airspace to all Pakistani carriers, mirroring Islamabad’s earlier decision to close its skies to Indian flights. As a result, Pakistan International Airlines (PIA) now must detour via Iran or Central Asia for flights to Malaysia, the Gulf, and the Far East. This leads to higher fuel costs and longer routes, directly affecting both PIA’s bottom line and the airline’s ability to serve passengers efficiently.

International airlines like Lufthansa and British Airways, which once flew over Pakistani airspace, have also suspended operations, citing security risks. Consequently, Pakistan stands to lose over $30–50 million annually in overflight fees, further deepening the financial strain on the aviation sector.

India’s decision to bar Pakistani-flagged vessels from entering its ports has been met with retaliation from Pakistan, further disrupting maritime trade. For Pakistan, this means that major exports — such as textiles, rice, and sports goods — are now facing logistical hurdles. Pakistani exporters will be forced to use more expensive and time-consuming routes via third-party ports.

The closure of ports directly impacts Pakistan’s shipping revenue, which is largely derived from dock handling, logistics, and shipping services. This loss could further destabilise Pakistan’s current account, putting additional pressure on the country’s already fragile financial situation.

Indus Waters Treaty suspended: A threat to agriculture

In perhaps the most provocative move, India has suspended the Indus Waters Treaty — a World Bank-brokered agreement from 1960 that governs river water sharing. This has far-reaching consequences for Pakistan, where up to 90 per cent of agriculture relies on these rivers for irrigation. The suspension of water flow from the Jhelum, Chenab, and Indus rivers threatens to cripple Pakistan’s farming sector, particularly in Punjab and Sindh provinces.

Farmers have already protested large-scale canal projects over concerns of water misallocation. If the suspension of the treaty continues, the agricultural sector faces the threat of massive crop failures, particularly in crucial areas like cotton production. Pakistan’s food security, cotton exports, and rural economy are now at risk, raising the potential for internal unrest and social instability.

India is also taking the economic war to international financial institutions. New Delhi has lobbied organisations such as the International Monetary Fund (IMF) and World Bank to reconsider their assistance to Pakistan, citing Islamabad’s alleged support for cross-border terrorism. With Pakistan already under a $7 billion IMF programme, the loss of international financial backing could deepen its economic woes.

Pakistan relies on multilateral funding to service debt obligations, finance development projects, and address its growing climate crisis. If global donors scale back their aid or reallocate resources elsewhere, Pakistan could face higher borrowing costs, delays in disbursements, and the risk of a credit downgrade, further pushing the country towards an economic crisis.

India’s post-Pahalgam response marks a shift in how it deals with cross-border terror — moving from conventional retaliation to economic isolation. While there are no troops mobilising along the border, every closed port, airspace restriction, and cancelled trade contract is a quiet but potent strike. These measures, though subtle, are strategically designed to weaken Pakistan’s economy without triggering full-scale military conflict.

For India, the economic retaliation carries minimal direct cost but sends a clear message of resolve. For Pakistan, the tightening noose around trade, transport, agriculture, and finance will be a hard one to bear, especially as the pressure from domestic industries, international creditors, and the global community begins to mount. The price of cross-border aggression is quickly becoming too high to ignore.

According to the International Monetary Fund (IMF), India’s GDP growth is projected to moderate from 8.2 per cent in 2023 to 7 per cent in 2024 and 6.5 per cent in 2025, as pent-up demand accumulated during the pandemic has been exhausted.

In contrast, the IMF has revised Pakistan’s projected GDP growth for 2025 to 3 per cent, down from 3.2 per cent forecasted earlier, reflecting ongoing economic challenges.