By Moaaz Manzoor

Renewed hostilities between the United States and Iran are raising fresh concerns for Pakistan's economy, with higher oil prices threatening to fuel inflation, widen the external deficit and complicate the country's IMF-backed fiscal reform programme.

Oil prices climbed to four-week highs on Tuesday after the United States reinstated a naval blockade of Iran and carried out a third consecutive night of strikes, reviving concerns over energy supplies through the Strait of Hormuz. The escalation also triggered heavy selling at the Pakistan Stock Exchange (PSX), where the benchmark KSE-100 Index fell 6,408.23 points, or 3.56%, to close at 173,518.82.

For Pakistan, the implications extend well beyond the stock market. Higher crude oil prices, freight costs and war-risk insurance premiums could increase the landed cost of fuel imports, widen the trade deficit and feed into transport, electricity and production costs across the economy.

The State Bank of Pakistan (SBP), in its June monetary policy statement, said headline inflation had risen to 10.9% in April and 11.7% in May, while the current account posted a deficit of US$0.3 billion in April as higher energy imports widened the trade gap. The central bank kept the policy rate unchanged at 11.5% and identified geopolitical developments, fuel-price pass-through and adjustments in electricity and gas tariffs among the key risks to the inflation outlook.

The latest geopolitical tensions come as the government targets a primary fiscal surplus of 2.5% of GDP in FY2025-26 and 2.0% in FY2026-27 under its IMF-supported reform programme, alongside efforts to broaden the tax base and reform public-sector enterprises. The SBP also noted that the Federal Board of Revenue (FBR) had revised its FY2025-26 tax collection target to around Rs13 trillion.

These commitments leave limited room for broad fuel subsidies. Passing higher international oil prices on to consumers would add to inflationary pressures, while absorbing the increase through lower taxes or subsidies could undermine revenue collection and fiscal targets.

The government has already increased the price of petrol by Rs13.18 per litre and high-speed diesel by Rs13.80 per litre, raising their prices to Rs310.71 and Rs323.30 per litre, respectively, with effect from July 11. It also doubled the Climate Support Levy to Rs5 per litre from July 1 under IMF-linked reforms while adjusting the petroleum levy.

A working paper by the Pakistan Institute of Development Economics (PIDE) warns that any disruption in the Strait of Hormuz would affect Pakistan through not only higher crude oil prices but also increased freight costs, insurance premiums and exchange-rate pressures.

According to the study, a mild disruption could raise inflation by 1.78 percentage points over six months, while stress and severe scenarios could increase inflation by 3.41 and 5.34 percentage points, respectively.

The paper also estimates that Pakistan's monthly petroleum import bill could rise by about US$142.3 million under a mild scenario, US$263.3 million under a stress scenario and US$384.3 million in a severe scenario. It identifies high-speed diesel as the main channel for second-round inflationary effects, given its extensive use in freight transport, agriculture and food distribution.

Analysts believe that if tensions in the region continue, Pakistan could face increasing pressure on inflation, external financing and fiscal management. They say policymakers will need to balance rising energy costs with IMF fiscal commitments while maintaining macroeconomic stability and supporting economic growth.

Speaking with Wealth Pakistan, Waqas Ghani, Head of Equity Research at JS Global Capital Limited, said repeated geopolitical tensions had made markets accustomed to volatility, but the broader concern continued to centre on Pakistan's external account.

"The bigger concern for institutional investors is not the daily swings in the stock market but the implications for Pakistan's external account," he said, adding that any prolonged disruption in the Strait of Hormuz would substantially increase the country's fuel import bill.

Syed Zafar Abbas, Manager at Zahid Latif Securities, said the conflict had affected financial markets worldwide and posed particular challenges for Pakistan given its fragile economic conditions.

He said sustained increases in crude oil prices could accelerate inflation and complicate monetary policy, potentially delaying or reversing any future interest-rate easing if inflationary pressures persist.

Credit: INP-WealthPk