Middle East Conflict Heightens Economic Risks for South Asia, Moody’s Warns

The ongoing conflict in the Middle East is emerging as a significant external shock for South Asia, with countries in the region facing heightened risks from energy price spikes, supply disruptions and weakening remittance flows, according to a new report by Moody’s Ratings.

The report cautions that while the direct geopolitical impact remains largely confined to the Middle East, the economic aftershocks are being transmitted globally—most acutely to lower-rated and import-dependent economies, including several in South Asia.

South Asia among most vulnerable

Moody’s identifies South Asia as one of the most exposed subregions within Asia-Pacific, citing its heavy reliance on Middle East energy supplies, fragile external balances, and dependence on remittances and tourism.

Countries such as India, Pakistan, Bangladesh and Sri Lanka face multiple transmission channels of stress. These include higher oil and gas import bills, disruptions in fertilizer supply, and tighter global financial conditions.

“Thin foreign-exchange buffers, high inflation sensitivity and dependence on external inflows make South Asian economies particularly vulnerable,” the report notes.

Energy and supply chain shocks

A key concern is the region’s dependence on crude oil and liquefied natural gas imports routed through the Middle East. Any disruption—especially through critical chokepoints like the Strait of Hormuz—could sharply raise energy costs and strain fiscal balances.

South Asia is also heavily reliant on Middle East-linked supply chains for petrochemicals and fertilizers. A sustained disruption could push up agricultural input costs, leading to higher food inflation and increased subsidy burdens for governments already under fiscal pressure.

Remittances and tourism at risk

The report highlights a second-order impact through declining remittances and tourism flows. Millions of South Asian workers are employed in Gulf economies, and any slowdown in the region could reduce income transfers back home.

A prolonged conflict could also disrupt air travel and connectivity via major Gulf hubs, dampening tourist arrivals in destinations such as Sri Lanka and the Maldives, further affecting foreign exchange earnings.

Fragile external positions

Among the most vulnerable are lower-rated sovereigns like Pakistan and Sri Lanka, which already face high external financing needs and limited policy flexibility. Bangladesh, despite recent stabilization, also remains exposed due to relatively weak reserve buffers.

Higher energy prices are expected to widen current account deficits across the region, while capital flow volatility could increase borrowing costs and pressure exchange rates.

Policy responses under strain

Governments in the region have begun responding to the shock. India, for instance, has ramped up domestic LPG production and prioritized household supply, while other Asian economies have resorted to subsidies, export controls, and strategic reserve releases to manage energy security.

However, Moody’s warns that prolonged price pressures could limit fiscal and monetary flexibility, forcing governments to balance inflation control with growth support.

Outlook uncertain

The agency emphasizes that the ultimate impact will depend on the duration and severity of the conflict, as well as each country’s policy response and existing financial buffers.

For South Asia, the report underscores a familiar vulnerability: exposure to global shocks through energy dependence and external inflows. With both channels now under strain, the region’s economic resilience faces a renewed test.