ME conflict clouds economic outlook

Pakistan's economy is entering a more uncertain phase as the Middle East conflict, sticky inflation and rising external risks threaten to disrupt the fragile macroeconomic stability achieved so far.

The conflict has already triggered volatility in international oil markets, with concerns over energy supplies through the Strait of Hormuz raising the risk of higher import costs for oil-dependent economies such as Pakistan.

According to an economic assessment by AKD Securities, the State Bank of Pakistan (SBP) is expected to maintain its policy rate at the upcoming Monetary Policy Committee meeting, with the central bank likely to adopt a cautious stance amid heightened geopolitical and economic uncertainty.

The report authored by Director Research Muhammad Awais Ashraf noted that Pakistan's foreign exchange reserves had improved significantly, reaching around $14 billion, while the current account remained largely contained. However, it cautioned that the outlook could deteriorate if geopolitical tensions persist and international energy markets remain volatile.

For Pakistan, prolonged disruption could have serious implications given the country's dependence on imported energy. Higher oil prices would increase the import bill, place pressure on the current account and potentially reverse some of the recent gains in external-sector stability.

The brokerage also highlighted the risk of higher inflation. It expects inflation to rise to around 5.9% in FY27 from an average of 7.1% in FY26, primarily because of disinflationary trends already visible in the domestic economy. However, it warned that the forecast could come under pressure if global commodity prices remain high for longer.

The report said the impact of the Middle East conflict would extend beyond oil prices, with potential spillovers into food and other commodity markets. Any sustained increase in import costs could feed into domestic inflation and complicate the monetary policy outlook.

The exchange rate could also face fresh headwinds if elevated energy prices persist. A sustained increase in the import bill would raise demand for foreign exchange and could offset the benefits of stronger remittance inflows. Any renewed pressure on the rupee would, in turn, raise the domestic cost of imported fuel and other essential commodities, creating a secondary inflationary impact.

On the external front, the brokerage said Pakistan's current account position remained manageable, supported by improved remittances and stronger services inflows. However, higher energy prices could quickly widen the external financing requirement and put pressure on the rupee.

The report also pointed to the potential impact on Pakistan's trade with Gulf economies. While the country's direct merchandise trade exposure to the region is relatively limited, remittances from Gulf-based Pakistani workers remain a crucial source of foreign exchange. A prolonged regional crisis could therefore affect both economic activity and the flow of remittances, depending on its impact on Gulf economies.

Any lengthy disruption to economic activity in Gulf countries could affect employment opportunities for Pakistani workers and, consequently, remittance flows. At the same time, heightened uncertainty could weigh on investor sentiment and delay investment decisions, particularly if the conflict begins to affect regional trade and transport routes.

The brokerage noted that the situation also posed risks to Pakistan's fiscal outlook. Higher oil prices could put renewed strain on subsidies and domestic fuel prices, while weaker economic activity could affect revenue collection.

While higher petroleum prices may increase government revenue through petroleum-related taxes and levies, the benefit could be outweighed by the challenge of shielding consumers from a sharp rise in domestic fuel prices. Any decision to absorb part of the international price shock would increase the burden on public finances, while passing the full increase on to consumers could accelerate inflation and weaken household purchasing power.

Meanwhile, the report expects Pakistan's real interest rates to remain substantially positive in FY27, with inflation projected to remain below the policy rate. This could provide some room for monetary easing, although the timing and pace of any rate cuts would depend heavily on developments in global energy prices and the domestic inflation outlook.

The geopolitical shock could therefore complicate the SBP's policy calculus. While subdued domestic demand and easing inflationary pressures could justify lower interest rates, a renewed surge in imported inflation or pressure on the exchange rate could limit the central bank's room to ease monetary policy.

The Strait of Hormuz remains a key risk factor in this regard. Continued disruption to shipping through the strategic waterway could amplify the impact on global energy markets and sharply increase transportation and insurance costs. For Pakistan, this would compound existing external-sector vulnerabilities and make the path towards sustained macroeconomic stability more challenging.

The report said the economic impact would depend on the conflict's duration and intensity. While improved reserves and external buffers could absorb a short-lived shock, a prolonged crisis could reverse gains in inflation, external stability and investor confidence. The brokerage expects the SBP to maintain a cautious policy stance, balancing growth support against renewed inflationary and external pressures.

It said Pakistan remained vulnerable to international energy prices, remittance flows and fiscal stress, with sustained stability depending on the government's ability to manage the fallout from geopolitical tensions.