Rising Border Tensions Hit Pakistan's Markets Hard

Turbulence has struck Pakistan's financial markets in April, with border tensions between India and Pakistan growing to a peak that hasn't been seen in years. A deadly terror incident in Jammu and Kashmir that left more than 27 people dead has caused diplomatic relations to go even further downhill between the two nuclear neighbors. Pakistan's Information Minister has warned that military engagement could be right around the corner, which has sent investor anxiety levels up and stability-seeking capital flowing out of the country's financial markets.

Pakistan's financial instruments are suffering as a result of the geopolitical backdrop. The country's dollar bonds have fallen almost 4% in April, and its equity markets have dipped nearly 3%. Foreign capital is stepping back, and local market sentiment is deteriorating, which makes the situation look even worse.

Divergence Between Indian and Pakistani Markets

Even as political uncertainty weighs down Pakistan's markets, Indian financial instruments remain resilient. This month the domestic equity and bond markets in India have achieved positive returns, standing in stark contrast to their neighbors to the northwest. The Indian economy, bolstered by relative political stability, seems to have insulated its capital markets from the fallout of border skirmishes.

This contrast highlights an emerging trend: risk-averse capital is flowing away from Pakistan, where political tensions and fears of conflict have reached new heights. Fund managers and analysts say that unless there is a rapid easing of hostilities, the Pakistani stock market will see continued capital outflows and valuation pressures, which will in turn accelerate the widening performance gap between it and the Indian stock market.

A Reversal From Recent Optimism

Prior to the latest friction, Pakistan's fiscal future was looking brighter. The nation had notched up its finest stock market show in over 20 years just the previous year, a performance driven by, among other factors, dropping oil prices and ascending credit ratings. And with those moves, there seemed to be a gathering interest among investors, a nascent stabilization of sorts.

This progress has now been stalled. What was once seen as a window for growth and capital inflow has shifted into a period of re-evaluation and caution. Although some market observers still maintain a constructive view on Pakistan in the medium term, the short-term outlook has become clouded by the possibility of further instability and external shocks, such as newly imposed US tariffs.

Opportunities Amid the Downturn?

In spite of the current sell-off, some analysts are expressing what can only be called potential silver linings. Avanti Save of Barclays Bank, for instance, notes that the recent slump in bond prices "might create attractive entry points for long-term investors." Her firm continues to hold an overweight position on Pakistan, banking, as she says, on the notion that geopolitical risk may be short-lived and that economic fundamentals may eventually reassert themselves.

Some, like Thomas Hugger from Asia Frontier Capital, believe that any kind of real recovery will depend on how quickly the tensions ease. If there's a diplomatic breakthrough, or even just a stabilization in the media rhetoric, confidence from investors could rebound modestly, allowing both stocks and bonds to recover some of the ground that they've lost.