Middle East Crisis Poses Grave Threats to Pakistan's External Sector
Pakistan has grappled with a persistent trade deficit throughout its history, with only brief exceptions in 1951 and 1972. Despite ongoing efforts to manage this gap through measures like curbing non-essential imports and seeking International Monetary Fund assistance, the country has relied heavily on foreign remittances and external debt to bridge the widening trade shortfall. However, the escalating Middle East crisis has disrupted this fragile external sector stability, transforming into a significant economic shock for Pakistan. The conflict, coupled with unpredictable U.S. presidential actions towards resolution, has imposed a heavy toll on developing economies like Pakistan, exposing vulnerabilities that demand urgent attention.
Export Sector Vulnerability Exposed
In recent years, Pakistan's exports to the Middle East, particularly to Gulf Cooperation Council countries, have shown steady growth, driven by sectors such as food, textiles, and IT services. For instance, in 2024, Pakistan exported $1.76 billion worth of goods to the United Arab Emirates and $700 million to Saudi Arabia, making these nations Pakistan's fifth and seventh largest global export destinations, according to ITC Trademap data from 2026. Based on the growth trajectory of GCC countries, there was optimism that exports could double within a few years. Unfortunately, the current Middle East crisis has shattered these hopes, jeopardizing the current $3 billion in annual exports to the region. Reports indicate that if the Strait of Hormuz remains closed for three to six months, Pakistan's exports to GCC countries could plummet by $1.5 to $2 billion, severely impacting the economy.
Energy Imports at Critical Risk
Pakistan imports a staggering 81 percent of its energy products from GCC countries, totaling $17.5 billion. The closure of the Strait of Hormuz could halt these energy imports, triggering a broader economic and political crisis. Energy is a crucial input for agricultural and industrial production, with Pakistan's transport, agriculture, and industrial sectors, including electricity generation, highly vulnerable to supply and price shocks. Specifically, 81 percent of Pakistan's petroleum and 99 percent of its liquefied natural gas imports originate from the Middle East. Therefore, the ongoing crisis, especially after potential Strait closures, poses a serious threat to Pakistan's energy supply lines and trade balance. Oil prices exceeding $100 per barrel would limit Pakistan's fiscal and financial space, exacerbating existing financial fragility, stagnant exports, and structural issues, making energy imports a significant hurdle in trade and production equations.
Freight Costs and Export Competitiveness
The Middle East crisis has led to a manifold increase in freight costs, halted oil supplies, spiked prices, disrupted exports, and fractured the global trading system following Iran's closure of the Strait of Hormuz. These events have introduced war premiums, and if the conflict escalates and expands to the Red Sea, global supply chains could be devastated, further increasing maritime freight costs. Pakistan's export sector, particularly the textile industry which accounts for approximately 60 percent of total exports, is already struggling with high operational and freight costs. The war premium may make it difficult for vessels to dock at Karachi and Gwadar ports, potentially bringing exports to a standstill. Thus, high freight costs are likely to destabilize Pakistan's exports, reducing competitiveness in international markets.
Exchange Rate and Remittance Vulnerabilities
The exchange rate is another casualty of the Middle East crisis. With meager foreign exchange reserves and limited export earnings, Pakistan is ill-equipped to protect its exchange rate or control volatility in a rapidly changing global environment. Pakistan's export basket lacks diversity, while its import basket is inelastic, meaning devaluation or depreciation cannot effectively correct trade balances, as noted by Hina in 2021. Additionally, remittances account for nearly 10 percent of Pakistan's GDP and play a vital role in stabilizing foreign reserves. In 2025, Pakistan received $38.3 billion in remittances, with $20.89 billion, or 54.5 percent, originating from GCC countries like Saudi Arabia, the UAE, and Qatar, according to State Bank of Pakistan data from 2026. Ongoing instability in the Gulf region, particularly uncertainty in labor markets, could reduce remittance inflows, significantly impacting Pakistan's ability to maintain external balance and foreign exchange reserves. A decrease in remittances would exacerbate financial vulnerabilities, potentially forcing reliance on external debt and loss of fiscal control.
Informal Trade and Energy Reserves
Prior to the crisis, Pakistan had around $3 billion in cross-border trade with Iran through porous borders, involving agricultural products, textiles, and petroleum derivatives. Border areas in Balochistan were closely connected with Iran for energy, essential items, and livelihoods, with Pakistani goods also transported into Iran. Disruption of this informal trade will have diverse impacts on Pakistan's external balance, depending on whether trade increases or decreases. Moreover, while increases in international oil prices affect all countries monetarily, their actual impact varies based on factors like oil import elasticity, domestic production, market diversification, and reserve stocks. For example, China maintains 230 days of oil reserves, India has 40 days, and Pakistan has increased its reserves to 27 days. This low buffer means Pakistan cannot easily absorb oil price hikes, leading to passed-on costs to producers and consumers, further deteriorating export competitiveness and adversely affecting the external sector.
Policy Recommendations for Mitigation
To address these challenges, the Pakistani government should diversify energy imports and restrict non-energy imports in the short term to reduce fiscal strain. Ensuring a smooth and stable energy supply to local industries is crucial. Additionally, Pakistan needs to restore trade with Iran and Afghanistan while seeking export avenues in China and ASEAN countries to alleviate stress on the external sector. Exploring new opportunities, such as transshipment and cargo handling at Karachi and Gwadar ports, can help integrate Pakistan into global supply chains and generate additional foreign exchange during these rapidly deteriorating times. By taking proactive measures, Pakistan can better navigate the economic shocks imposed by the Middle East crisis and safeguard its external sector stability.
