The April 22 massacre of 26 tourists in Pahalgam has reignited one of the world’s most combustible rivalries. Within hours, nightly exchanges of small-arms fire were reported along the Line of Control, the Indian Navy test-fired long-range missiles, and Pakistan’s aviation regulator warned that “all options are on the table” if India escalates further.
After just a couple of years of maintaining fragile peace, India-Pakistan relations have soured again in the aftermath of recent terror attacks in Pahalgam. India has retaliated with several measures such as suspension of Indus Water Treaty and revocation of SAARC visa for Pakistani holders. While Islamabad has denied the allegations while also calling India’s reactions knee-jerk, the economic impacts of the fallout will reverberate in the Pakistani economy which is already in shambles.
READ | Services up, goods down: India eyes gains in Trump-era trade order
Global capitals took note: Washington urged both sides to find a “responsible solution”, while Beijing—manager of its own Himalayan disputes—pressed for restraint. The United Nations quietly opened back-channel contacts with New Delhi and Islamabad, diplomats say, fearing the precedent that weaponising a water pact might set.
However, it is not just New Delhi which has imposed diplomatic and economic curbs rather Pakistan has also taken some steps. For now, experts believe that these measures will not cause serious damage but an easily bearable pain.
One of Islamabad’s most visible counter-moves was to close the Attari–Wagah land checkpoint and suspend all formal trade—an action largely symbolic given the tiny volumes involved, yet disruptive for small consignments that had begun moving through Dubai-based re-exporters. Simultaneously, Delhi cancelled 14 categories of Pakistani visas and ordered 4,000 visitors to leave within a week, hardening the people-to-people freeze.
Airspace as battleground
Steps taken by Pakistan to pinch India include barring Indian airlines from using its airspace which means carriers like SpiceJet, IndiGo will have to take a longer route, incurring more expense. While these companies may bear some of the additional costs, eventually these will be passed on to the fliers. Or, exporters and importers can use foreign-owned airlines which are currently not in the purview of Pakistani officials.
Analysts at CAPA India estimate that a one-month closure could cost Indian carriers up to US $15 million in extra fuel and crew costs and drive fares on busy Gulf and Europe routes 30-45 per cent higher—an unwelcome squeeze just as fleets cope with Boeing and Airbus delivery delays.
India is going to see some economic fallouts but not necessarily because of Pakistani retaliatory measures but due to the Pahalgam attack itself. The 22 April attack will dampen tourism in the state but also put a halt on the rising investment flows. In FY25, the value of new investment projects in Jammu & Kashmir hit Rs 31,644 crore marking a 328.4% year-on-year rise. While the attack may not hurt long-term sentiments for private investors, Kashmir is expected to witness some hiccups in the short term.
Those jitters are already visible. More than 25,000 hotel bookings were cancelled within three days of the attack, according to the Kashmir Hoteliers’ Association, and airlines laid on “rescue flights” as panicked tourists fled a region that welcomed a record three million visitors in 2024.
India-Pakistan bilateral trade
India’s trade with Pakistan is almost negligible as in 2023-2024, India imported goods worth $2.88 million which amounts to 0.0004% of India’s total imports while exporting goods worth $1,189 million, primarily cotton, sugar, and pharmaceuticals, which is 0.2730% of New Delhi’s total exports. Before the attack, India-Pakistan trade agreements included cooperation and mutual assistance in Customs diversification and enhancement of trade and other treaties but a revocation of the same is unlikely to hurt the trade prospects of either country.
In fact, the entire 2024 merchandise trade basket—about $1.2 billion—amounts to less than 0.05 per cent of India’s global commerce. Pakistan’s abrupt freeze therefore inflicts more domestic pain than external leverage, particularly in active-pharmaceutical-ingredient imports that Indian suppliers dominate.
What Pakistan will actually see is an erosion of confidence in its already tainted image. The country was on a five-year watchlist on the Financial Action Task Force grey list until 2023 which already limits its access to global financing, and renewed scrutiny over terrorism could further restrict capital inflows.
European parliamentarians have floated the idea of tying Pakistan’s GSP-Plus trade preferences to “credible anti-terror commitments”, while rating agencies warn that another grey-listing would widen sovereign spreads just as Islamabad faces $24 billion in external repayments over the next 12 months.
The south-Asian country’s economy was already teetering before this crisis. With a GDP of approximately $305 billion, foreign exchange reserves dwindling to $10.5 billion, and a debt-to-GDP ratio hovering at 70%, the country has been grappling with chronic economic fragility. Pakistan witnessed inflation hitting 38.5% in 2023 and its currency has also lost significant value, which has caused a cost-of-living crisis for millions.
The nation’s reliance on external borrowing, including $30 billion owed to China and recent loans from Saudi Arabia and the UAE, highlight its precarious financial state. Compared to Pakistan, only default-stricken Sri Lanka, Ghana and Nigeria were worse off some time ago. The Pahalgam attack and India’s retaliatory measures have now piled additional pressure on an economy that can ill afford further disruption.
Fresh numbers from the Asian Development Bank underscore the squeeze: Pakistan’s FY 25 growth estimate has been pared back to 2.5 per cent, barely above population growth, with officials citing “heightened geopolitical risks and tightening external finance.”
Another big hit for Pakistan is the suspension of the Indus Water Treaty. Islamabad depends heavily on the Indus River system for agriculture, which accounts for 24% of its GDP and employs nearly 40% of its workforce. Cities like Karachi, Lahore, and Multan also rely on these waters for drinking and municipal use. While India cannot immediately halt water flow due to the time required to build new dams, there are serious long-term risks to Pakistan’s water security. Any significant reduction in water supply could devastate crops, trigger food shortages, and cripple hydropower generation, which constitutes 25% of Pakistan’s electricity.
Legal scholars note that New Delhi has stopped the mandatory daily flood-data transmissions required under the 1960 pact, and is fast-tracking six run-of-river projects whose cumulative storage could, in theory, delay early-season flows by up to a week—enough to unsettle planting cycles downstream. The World Bank, guarantor of the treaty, says it is “reviewing” India’s unilateral move.
At this stage, Pakistan cannot afford a military conflict with India either. It has been back from the brink of bankruptcy and is still not out of danger. Its economy is barely recovering while the country survives on loans. A military conflict with India will spell doom for Pakistan’s economy. This is when the war rhetoric has been high in India, jacked up by media frenzy as well as nationalist movies.
That rhetoric has found an echo across the border: Pakistan’s aviation minister publicly alluded to its “full-spectrum deterrence”, a phrase that in local strategic jargon includes tactical nuclear weapons. Strategic analysts warn that habitual brinkmanship, compounded by social-media disinformation, leaves scant margin for miscalculation.
Markets on a knife edge
As a fallout of India’s retaliation, the Karachi Stock Exchange plummeted 2,565 points on April 24, reflecting investor panic over escalating tensions and trade disruptions. Pakistan’s economic vulnerability can also be gauged by the Asian Development Bank’s downgrade of growth forecast for 2025, from 3% to 2.5%, and the IMF’s warning of fiscal risks added to the gloom.
The rupee followed, slipping to a record 305 per dollar before the central bank intervened; credit-default-swap spreads blew out 120 basis points in two days, signalling a higher perceived probability of default.
India continues to position itself as the voice of the global south and has backing of strong allies. If India leverages its growing global market influence, it could pressure Pakistan’s ally nation to reconsider their support.
New Delhi’s G20 presidency last year and its expanding defence ties with the United States give it diplomatic clout that Islamabad struggles to match. Gulf investors—once reliable balance-of-payments stop-gaps for Pakistan—now weigh Indian infrastructure bonds as an alternative.
In the light of this, Pakistan needs to immediately work on gaining India’s good faith as de-escalation is not just a diplomatic necessity but an economic imperative for the crumbling nation. Cooperating on counterterrorism and seeking third-party mediation may avert further economic damage.
The alternative—a prolonged stand-off in which water, trade and tourism are weaponised—would leave both societies poorer and the wider region far less stable. For two nuclear-armed neighbours trapped in climate-stressed South Asia, that is a wager neither can afford to place.