The Economic Fallout of Terrorism in Pakistan: A Crisis Rooted in Policy and Power

Except for Afghanistan, which has endured extreme instability over the past two decades, Pakistan remains one of the region’s poorest economic performers. The country has repeatedly relied on bailouts and structural adjustments from the International Monetary Fund (IMF), while also receiving substantial financial support from China and Gulf nations. Nevertheless, the trajectory of Pakistan’s economy is deeply intertwined with terrorism. While the state claims to be a victim of terrorism, it has also served as a sanctuary for terrorist groups responsible for numerous attacks across South Asia and beyond. A striking example is Osama bin Laden, who was found hiding in Pakistan during his final days.

This dual role has severely damaged Pakistan’s economic prospects. Historically aligned with the West during the Cold War and enjoying an open economy, Pakistan still failed to match the success of the so-called Asian Tigers, despite similar external support. Longstanding conflicts with India, wealth concentration among feudal elites, military dominance, and unstable civilian governments have collectively stunted Pakistan’s growth and undermined good governance.

Terrorism has particularly discouraged foreign direct investment (FDI). Empirical studies show a negative correlation between terrorist activity and FDI inflows. A study published in the Review of Economic Perspectives noted that a 1% increase in terrorist incidents leads to a 0.104% drop in FDI, a 0.039% decline in domestic investment, and a 0.002% reduction in economic growth. The State Bank of Pakistan reported that FDI dropped from USD 5.4 billion in 2007–08 to just USD 820 million in 2011–12, during a period of intense terrorist activity in cities like Lahore, Karachi, and Peshawar.

Domestic businesses have suffered as well. Many local enterprises have downsized, relocated, or shut down altogether. The All-Pakistan Business Forum estimated that terrorism caused a 40% decline in small and medium-sized enterprises (SMEs) from 2009 to 2014. Karachi, once the country’s economic hub, became a battleground for extortion rackets run by criminal and terrorist networks. Public infrastructure also faced repeated attacks. Continuous assaults on railways, gas pipelines, electricity grids, and roads have led to soaring maintenance costs. According to the Ministry of Finance, terrorism inflicted losses exceeding USD 126 billion between 2001 and 2020.

Pakistan’s persistent failure to take concrete action against terrorist groups has compounded its problems. While it portrays itself as a victim—especially in the face of Indian allegations of sponsoring militancy in Jammu and Kashmir—its inaction has had grave consequences. One of the most significant repercussions was Pakistan’s placement on the Financial Action Task Force (FATF) grey list from June 2018 to October 2022. The designation followed Pakistan’s failure to curb financial flows to proscribed groups like Lashkar-e-Taiba, Jaish-e-Mohammed, and the Haqqani Network.

Greylisting had severe economic consequences. It subjected Pakistani financial transactions to greater scrutiny, causing delays and raising compliance costs. International banks and businesses became wary of engaging with Pakistan due to regulatory and reputational risks. The Ministry of Finance estimated that greylisting cost the economy roughly USD 38 billion in GDP losses from 2008 to 2019. It also hindered Pakistan’s negotiations with the IMF and other creditors. In 2021, the IMF explicitly linked progress on the FATF action plan to the release of bailout tranches. The greylisting not only tarnished Pakistan’s international image but also restricted its access to emergency liquidity and concessional funding.

Following the West’s withdrawal, China emerged as Pakistan’s primary financial backer. Launched in 2015 under Beijing’s Belt and Road Initiative (BRI), the China-Pakistan Economic Corridor (CPEC) pledged more than USD 60 billion for infrastructure development, including roads, energy projects, and industrial zones. Marketed as a “game-changer,” CPEC aimed to boost GDP, create jobs, and modernize logistics. However, critics argue that it has worsened Pakistan’s financial vulnerabilities. As of 2023, Pakistan owed roughly USD 30 billion to Chinese creditors—more than one-fourth of its total external debt. Much of this debt is non-concessional, bound by opaque commercial terms and dollar-based repayments, putting pressure on Pakistan’s dwindling foreign reserves. The IMF’s 2022 report expressed concern over the lack of transparency in Chinese financing and its impact on debt sustainability. Any sovereign default or debt restructuring would give China disproportionate leverage over Pakistan’s economic, foreign policy, and security decisions.

Moreover, terrorist attacks on Chinese nationals have strained bilateral relations. Groups like the Balochistan Liberation Army (BLA) view CPEC as exploitative and have targeted Chinese engineers and convoys. In response, Pakistan has had to establish dedicated security units, costing over USD 150 million annually—funds that could otherwise support development.

Terrorism in Pakistan is not an organic phenomenon; it is deeply embedded in the country’s political economy. The military’s historical use of non-state actors in Afghanistan and Kashmir has fostered a toxic security environment. Many of these actors have turned inward, fueling insurgencies and sectarian violence. The civilian leadership, driven by electoral concerns and ideological sympathies, has often failed to dismantle these extremist networks. State funding continues to flow to seminaries with alleged terrorist ties. Although the National Action Plan (NAP), launched after the 2015 APS Peshawar massacre, laid out ambitious goals, implementation remains weak. Unless the ideological and financial roots of terrorism are uprooted, the economic destruction will persist.

The recent Pahalgam attacks and the shifting security dynamics in South Asia underscore the region’s vulnerability. For India and Pakistan—two nuclear-armed rivals—terrorism poses not just a security threat but a major economic barrier. For Pakistan, in particular, terrorism has redefined its global standing, limited its policy autonomy, and reshaped its economic model. While reputational harm and international isolation are serious indirect costs, the direct economic losses—in terms of missed investment and output—are staggering.

Pakistan’s increasing reliance on China risks locking it into a lopsided, debt-driven relationship. Unless terrorism is addressed as a structural issue involving politics, ideology, and finance—not merely a tactical challenge—the country will remain trapped in a cycle of insecurity and underdevelopment. Breaking free requires courageous reforms, a reorientation of foreign policy, and a long-term vision grounded in democracy, peace, and equitable growth.

Harsh Pandey is a doctoral researcher at the School of International Studies, Jawaharlal Nehru University (JNU), New Delhi. He is also a Life Member of the International Centre for Peace Studies, New Delhi, where his academic and professional interests focus on issues of international relations, peacebuilding, and regional security.