Pakistan’s bid to mediate between the US and Iran has put Islamabad near the centre of efforts to defuse the Middle East conflict, but with no lasting peace yet in sight, its fragile economy is becoming increasingly exposed to the fallout from the war.
While soaring oil prices and disrupted flows through the Strait of Hormuz have led to turmoil in global energy markets, analysts said Pakistan has especially limited room to absorb the blow because of its thin foreign exchange reserves, dependence on imported energy and reliance on IMF-backed reforms.
With peace efforts stalled after a temporary ceasefire earlier in April, one potential source of relief has faded, leaving Islamabad facing a rising import bill, tighter external financing and more conditional support from Gulf partners at a time when domestic energy curbs could weigh on growth.
A report by Oxford Economics warned that higher oil prices could quickly erode the country’s foreign exchange buffers if imports and remittances do not adjust.
Callee Davis, senior economist at Oxford Economics, said the firm’s updated forecast assumed oil would average US$113 per barrel in the second quarter of 2026 before easing to US$79 by the end of the year.
Under that scenario, and with no change in imports or remittance behaviour, Pakistan’s reserves would “deteriorate sharply”, falling to US$6.8 billion by the end of 2026 and approaching US$1.6 billion by the 2028 financial year, Davis said.
The blockade of the Strait of Hormuz has choked off flows of crude, natural gas and oil products since the war began at the end of February, pushing Brent crude briefly past US$126 per barrel on Thursday, its highest level in four years, from about US$70 before the conflict.
The disruption has raised costs for energy importers such as Pakistan, even as the US expands pressure on Tehran by targeting Iran-linked oil tankers and buyers of Iranian crude.
Pakistan has implemented sweeping austerity and fuel conservation measures to reduce oil imports and curb energy consumption since March.
These include a four-day work week, 50 per cent remote work and 50 per cent fuel allowance cuts for government vehicles, as well as two-week school closures.
The Oxford Economics report, released on Monday, said lower imports in Pakistan due to policy curbs and weaker demand were likely to ease immediate pressure on the country’s reserves.
But it warned such measures would also intensify domestic shortages, raise inflation and weigh on growth, increasing risks for the country’s IMF bailout programme.
The 37-month US$7 billion programme, approved in September 2024, has helped stabilise Pakistan’s economy after a severe balance-of-payments crisis that brought the country close to default and sent inflation soaring.
But that recovery remains fragile, with the funding heavily dependent on strict adherence to conditions focused on fiscal discipline, tax expansion and governance reforms.
Oxford Economics said Pakistan would likely be able to manage the pressure through moderate import compression – cutting or curbing imports to preserve foreign exchange – while remittances from the Gulf region, a major source of income for South Asian workers, remained stable.
But it also saw a substantial risk of a worse scenario in which remittances weakened and external financing became harder to secure.
“While stronger import compression would partially offset this shock, reserve dynamics would deteriorate over time, and the risk of external distress would rise significantly as financial assurances from Gulf partners and China become more conditional, and the credibility of the IMF programme weakens,” said Davis.
Pakistan’s economy is heavily dependent on external financing from China and Middle Eastern countries, including Saudi Arabia and the United Arab Emirates, and that dependency has become critical for maintaining foreign exchange reserves and servicing debt.
Saudi Arabia stepped in with substantial financial assistance for Pakistan, helping it navigate a major debt repayment of roughly US$3.5 billion to the UAE earlier this month.
The UAE’s request for repayment came as a major surprise to Pakistan and the IMF, as the funds had previously been expected to be rolled over until the end of Pakistan’s programme in 2027, according to the Financial Times.
The move strained ties and forced Islamabad to seek urgent financial support, with Saudi Arabia stepping in to help avert an immediate balance of payments crisis.
Saudi Arabia’s assistance to Pakistan “should avert an immediate balance of payments crisis, but Gulf financing is becoming more conditional”, Oxford Economics said.
Gulf ties under strain
Priyajit Debsarkar, a London-based political commentator, said Pakistan’s squeeze could not be separated from wider strains among Gulf powers, whose rivalries and security concerns have sharpened during the conflict.
That was evident not only from the UAE’s decision to demand debt repayment from Pakistan, he said, but also from its departure from the Organisation of the Petroleum Exporting Countries (Opec).
Opec sets production ceilings and individual quotas for its members to manage global oil supply and influence prices, giving the UAE-Saudi split wider significance for oil markets and Pakistan’s energy costs.
Differences within the old order of the oil market have come to the fore as the UAE and Saudi Arabia increasingly compete over regional politics and economic issues, particularly in the Red Sea region.
The split matters for energy markets because both countries have substantial spare capacity, meaning they can raise production relatively quickly when supply is disrupted – giving them unusual influence over prices that directly affect energy importers such as Pakistan.
Pakistan has often acted as a guardian of Saudi Arabia against external threats. Since the 1970s, Pakistani troops have been stationed in the kingdom for training, advice and security.
But the latest strains suggest Islamabad’s traditional reliance on Gulf partners is becoming more complicated at a time when it can least afford uncertainty.
Debsarkar said the UAE’s recent decisions reflected frustration over attacks on cities such as Dubai and Abu Dhabi during the Iran war, as well as a broader reassessment of its regional partnerships.
Abu Dhabi appeared to be moving towards new oil and security alignments in which Pakistan was unlikely to play a “pivotal role”, he said, helping explain why it had sought repayment rather than continuing to provide financial support.
scmp.com