by Rayaan Khan
Pakistan’s economy has entered a period of fragile stabilization, but that stability remains highly exposed to internal and external shocks. Over the past year, growth has improved modestly, inflation has fallen from its peak, and foreign exchange reserves have recovered. Yet these gains coexist with deep structural weaknesses: a heavy debt burden, dependence on imports, a narrow export base, and persistent reliance on remittances and external support. At the same time, global political conflict has become a more direct economic force. The Middle East conflict, rising tensions around Iran, and wider geopolitical fragmentation have pushed up oil prices, fuel costs, and uncertainty in financial markets, placing renewed pressure on Pakistan’s inflation, budget, currency, and growth outlook.
Pakistan’s financial market is best understood as a bank-led system, with the State Bank of Pakistan (SBP) trying to balance stability and growth. As inflation eased, the SBP reduced the policy rate substantially from the exceptionally high levels reached in 2024, bringing it down to 12.0 per cent by January 2025 before reducing it further thereafter, helping to revive lending and support economic activity. The World Bank also notes that the banking sector remained resilient, while government securities absorbed a very large share of credit, showing how closely the state and banks remain linked. At the same time, private sector credit began to recover, especially in manufacturing, wholesale and retail trade, information and communication, consumer finance, and agriculture. This matters because a financial market cannot truly support long-term growth if most savings are channelled into government borrowing rather than productive investment.
Recent macroeconomic data show both progress and fragility. Pakistan’s GDP growth reached 3.0 per cent in FY25, slightly above 2.6 per cent in FY24, driven mainly by a rebound in industrial output. Inflation fell sharply to 4.5 per cent in FY25 from 23.4 per cent in FY24, helped by lower commodity prices, stabilising electricity tariffs, and a more market-based exchange rate. Record remittances helped offset a trade deficit and pushed the current account to a surplus of 0.5 per cent of GDP, the highest in two decades, while gross reserves rose to US$15.8 billion, equal to about 2.5 months of import cover. Yet the public debt burden remained high at around 73 per cent of GDP, and the fiscal deficit still stood at 5.4 per cent of GDP. These figures show why Pakistan can stabilise for a period without yet becoming secure.
The foreign exchange market is central to this story. The World Bank stresses that a fully market-determined exchange rate and a liquid interbank market are essential for restoring confidence, attracting investment, and avoiding sudden disruptive adjustments. In Pakistan’s case, the rupee’s relative stability in FY25 was supported by reforms, stronger remittances, and external financing, but this stability remains vulnerable if imports surge or confidence weakens. That is why the financial market cannot be discussed only in terms of shares and banks; the exchange rate, government borrowing, and external reserves are equally important. Pakistan’s growth model has still relied too much on debt- and remittance-financed consumption rather than export dynamism, which leaves the financial system exposed whenever global conditions worsen.
This is where current global political conflict has become especially damaging. The Russia–
Ukraine war and the wider energy shock pushed up global prices for oil and gas, while the Middle East conflict in 2026 created fresh disruption. Reuters reported that Pakistan raised fuel prices sharply in March and again in April 2026 because of the surge in global oil prices linked to conflict involving Iran, with petrol and diesel rising dramatically in response. The IMF has also warned that the Iran-related shock is disrupting a significant share of global oil and LNG flows, making poorer import-dependent countries more vulnerable to inflation and slower growth. For Pakistan, which depends heavily on imported energy, these shocks quickly spill over into transport costs, food prices, electricity tariffs, and business confidence.
The impact on the wider economy is immediate. Higher fuel costs feed into the import bill, widen the trade deficit, and reduce the government’s fiscal room. They also make the SBP’s job tougher because the central bank must choose between supporting growth and protecting price stability. Reuters reported that the SBP held its policy rate at 10.5 per cent in March 2026 as oil risks clouded the inflation outlook, showing how quickly external conflict can interrupt monetary easing. The government’s 2026–27 budget has also been shaped by this environment: defence spending was raised by 18 per cent, development spending was squeezed, and the overall fiscal deficit was targeted at 3.6 per cent of GDP, all while inflation returned to double digits because of oil shocks. In other words, conflict abroad is not abstract for Pakistan; it reshapes domestic policy choices in real time.
The stock market is another channel through which conflict is felt. Pakistan’s market has shown that it reacts quickly to political and geopolitical news. When tensions in the Middle East intensified, Reuters reported sharp volatility in the Pakistan Stock Exchange, with investors pulling back as uncertainty over ceasefires and regional escalation increased. That reaction matters because equity markets are not only about wealth creation for a narrow investor class; they also signal confidence in the economy. If investors believe oil prices will stay high, the rupee may weaken, earnings may fall, and borrowing costs may rise. By contrast, when the IMF programme and reform measures appear credible, sentiment improves. The financial market therefore reflects a constant tug of war between domestic reform optimism and external shock anxiety.
Pakistan’s export structure makes the country especially vulnerable to such shocks. The World
Bank notes that exports of goods and services have fallen from around 16 per cent of GDP in the 1990s to around 10 per cent in 2024, leaving the economy over-dependent on debt- and remittance-led consumption. That weakness matters because global conflict tends to disrupt exactly the areas Pakistan relies on most: shipping routes, energy prices, trade finance, and overseas labour income. When remittances are strong, they can cushion the external account; when they are threatened, pressure returns quickly. This is why the most important lesson from the present moment is that financial stability cannot rest only on IMF support or temporary reserve gains. Pakistan needs a broader export base, a more flexible exchange rate, deeper trade finance, and less dependence on imported fuel if it is to reduce its exposure to external conflict.
Pakistan’s financial market is stabilising, but not yet secure. The banking sector is functioning better, inflation has eased from crisis levels, reserves have improved, and the current account briefly moved into surplus. However, the economy still faces high debt, a narrow export base, and a financial system that remains closely tied to government borrowing. Current global political conflicts have made these weaknesses more visible by pushing up energy costs, straining the exchange rate, increasing inflationary pressure, and limiting fiscal space. The right response is not panic, but discipline: maintain macroeconomic stability, protect social spending, diversify energy and trade sources, and deepen reforms that encourage productive private investment. Only then can Pakistan’s financial market become a platform for durable growth rather than remaining a mirror of recurring economic crises.
The writer is a student at ISOI and can be reached at rkhan05112009@gmail.com
