India and Pakistan are the closest they have been to military conflict in years following last month’s devastating attack on Indian tourists in held Kashmir. The turmoil couldn’t come at a worse time for the economies of the two nuclear-armed nations, according to Bloomberg.
For India, the crisis has struck in the middle of intense negotiations over a trade deal with the US that New Delhi hopes will spare it from US President Donald Trump’s so-called reciprocal tariffs. Indian Prime Minister Narendra Modi has been counting on the pact to bolster India’s pitch to global investors that it is a haven from Trump’s trade war.
Pakistan, for its part, is pulling itself out of an economic crisis that brought it close to bankruptcy -- helped by a $7 billion International Monetary Fund loan programme. The government is pushing ahead with its most serious economic reforms in decades to secure more relief.
The attack in held Kashmir, which Modi’s government has labelled an act of terrorism, is now forcing both countries to shift their attention away from these economic priorities and back to their decades-long rivalry over the disputed Himalayan region.
“That this happened at this very moment -- it’s very unfortunate,” said Alicia Garcia-Herrero, chief economist for Asia Pacific at Natixis. For New Delhi, in particular, “all of this massive global allure for India will be, in a way, postponed,” she said.
Relations between the two countries have reached a low point since the April 22 attack in held Jammu and Kashmir, which left 26 civilians dead. India has blamed the massacre on Pakistan, which denies involvement.
On Sunday, Indian Defence Minister Rajnath Singh said India would give a “befitting” reply to the carnage. Pakistan has vowed to respond to any attack, and on Monday tested a surface-to-surface missile for the second time in recent days. It said it would formally apprise the United Nations Security Council of the situation.
Risks of conflict
For India, the potential hazards of a military conflict are high. Modi is pitching India as an investor-friendly destination and a bastion of stability in Asia as it topples longstanding trade barriers. Early signs are emerging that India could be a major beneficiary of Trump’s trade war, with multinational firms like UBS AG and Apple Inc shifting more of their operations to the South Asian country.
A drawn-out conflict could also distract from New Delhi’s efforts to secure a bilateral trade deal with the US -- an outcome that’s “very close,” according to US Treasury Secretary Scott Bessent. If India comes across as the aggressor, it could throw up hurdles in talks over separate pacts that India wants to strike with the European Union and the UK, said Garcia-Herrero.
Military conflict also risks involving China, India’s chief regional rival and Pakistan’s longtime backer. After the attack, Beijing said it was “Pakistan’s ironclad friend and all-weather strategic cooperative partner” and “fully understands Pakistan’s legitimate security concerns.”
For India, there’s little upside to a protracted conflict, said Imtiaz Gul, executive director of the Islamabad-based Center for Research and Security Studies. “They know once they get into an arms escalation it will create uncertainty and they wouldn’t risk their economy even for a day,” he said.
The long-term risks of military escalation for Pakistan are also severe. The country is trying to rebuild its tattered economy after coming close to a default in 2023. Islamabad is working to secure a reprieve from pending 29 per cent reciprocal tariffs imposed by the Trump administration.
The country has said it will send a trade delegation to Washington in the coming months to bridge its trade gap with the US, Pakistan’s largest export market. The economy has stabilised -- inflation is low -- but only after the fastest wave of price gains in its history. Pakistan’s debt, only borderline manageable, is contingent on regular relief from loans by China, Saudi Arabia and the United Arab Emirates.
“From a market standpoint, Pakistan looks the more vulnerable,” said Philip McNicholas, an Asia sovereign strategist at asset manager Robeco.
Markets recover
Even with tensions high, stock markets in India have shown resilience after the Kashmir attack. India’s benchmark NSE Nifty 50 Index climbed to a new high for the year on Friday, while the Indian rupee reached a seven-month peak. Pakistan’s main benchmark has also pared losses from a post-attack dip.
“There is a lot of jingoism between both sides,” said Suleman Rafiq Maniya, an independent wealth manager in Karachi. While limited military strikes remain a possibility, neither country wants a drawn-out conflict, he said, adding that none of his clients are exiting from their domestic stocks.
“I feel there will be a dial-down very significantly in the next few weeks,” he said.
In the end, however, India may feel it has little choice but to retaliate, despite the economic risks, said Indrani Bagchi, chief executive of the Ananta Aspen Centre, a think tank in New Delhi.
“The attack is a strike at the very core of what is India. Therefore not responding is not an option,” she said. “India cannot be seen as putting the economy ahead of its national security concerns.”