Assessing Geopolitical Risks in South Asia: Implications for Regional Markets Amid Pakistan-Afghanistan Tensions

The Pakistan-Afghanistan borderlands have long been a fault line of geopolitical instability, but 2025 has seen a recalibration of risks and opportunities. While cross-border tensions persist—marked by military clashes, militant activity, and forced migration—the region’s economic integration has paradoxically deepened. This duality of conflict and cooperation is reshaping investment flows and asset valuations in South Asia, creating a complex landscape for investors.

Economic Diplomacy Amid Security Fractures

The July 2025 Preferential Trade Agreement (PTA) between Pakistan and Afghanistan, which slashed tariffs on agricultural commodities like tomatoes and fruits from 60% to 27%, has driven bilateral trade to $989 million in the first half of the year [1]. This growth defies the backdrop of border closures, such as the Torkham crossing shutdown in early 2025, which initially cost Pakistan $15 million and Afghanistan $10 million in lost trade [4]. The PTA’s success underscores a strategic pivot toward economic diplomacy, even as security threats—such as the Tehrik-e-Taliban Pakistan (TTP)’s 70% surge in cross-border attacks—remain unresolved [2].

China’s role as a mediator has further stabilized the corridor. The China-Pakistan Economic Corridor (CPEC) and the Uzbekistan–Afghanistan–Pakistan Railway are not just infrastructure projects but geopolitical tools to counteract instability. For instance, Afghanistan’s alignment with CPEC has positioned it as a transit hub, attracting modest foreign direct investment (FDI) in mining and energy sectors [2]. However, structural weaknesses—such as Afghanistan’s 5–6% inflation rate and reduced foreign aid—limit the sustainability of this growth [4].

FDI Trends: A Tale of Two Economies

Pakistan’s FDI inflows in FY2025 reached $2.46 billion, a marginal increase from the previous year, driven by projects like the $6.6 billion Reko Diq Copper-Gold Mine [2]. Yet, the country’s investment climate remains fragile: political uncertainty, high inflation, and security risks deter long-term commitments. The U.S., Pakistan’s largest FDI source, has scaled back investments in renewable energy and agribusiness due to regional volatility [3].

Afghanistan, meanwhile, faces a starkly different reality. Despite a 2025 FDI inflow of $1.7 billion—a rebound from the $20.6 million recorded in 2021—its asset valuations remain depressed. The mass return of 2.7 million Afghans from Pakistan and Iran in 2025 has strained housing markets, pushing non-food inflation to 2.7% as housing costs rose 11.7% [1]. Bond yields in Afghanistan reflect this fragility, with limited access to finance and reduced donor support constraining economic recovery [3].

Asset Valuations: Volatility and Resilience

The Pakistan Stock Exchange (PSX) has experienced sharp volatility, with the KSE 100 Index dropping over 2,100 points following the Pahalgam attack in April 2025 [1]. However, the market rebounded after a U.S.-brokered ceasefire in May 2025, illustrating the sector’s resilience to short-term shocks. In contrast, Afghanistan’s informal markets remain highly sensitive to border closures and militant activity. For example, the closure of the Ghulam Khan crossing in 2025 disrupted 150 trucks carrying Afghan goods to India, exacerbating inflationary pressures [5].

Investor Strategies in a Fractured Landscape

For investors, the key lies in balancing risk mitigation with opportunistic exposure. Diversification into mid- and small-cap stocks in India’s infrastructure and technology sectors—less correlated with regional volatility—has gained traction [2]. In Pakistan, sectors like telecommunications and renewable energy offer growth potential despite macroeconomic headwinds. Meanwhile, Afghanistan’s mining and agriculture sectors, though high-risk, present undervalued opportunities for those willing to navigate political and security uncertainties.

Conclusion

The Pakistan-Afghanistan borderlands exemplify the dual forces of destabilization and integration. While cross-border tensions persist, economic diplomacy and infrastructure investments are creating pathways for growth. Investors must navigate this duality with caution, leveraging data-driven insights to hedge against volatility while capitalizing on emerging opportunities.

Source:
[1] Tariffs And Talks: Economic Diplomacy Reshapes Pakistan-Afghanistan Ties [https://www.eurasiareview.com/28072025-tariffs-and-talks-economic-diplomacy-reshapes-pakistan-afghanistan-ties-oped/]
[2] Amid Volatility and Opportunity [https://stratheia.com/amid-volatility-and-opportunity/]
[3] 2024 Investment Climate Statements: Pakistan [https://www.state.gov/reports/2024-investment-climate-statements/pakistan]
[4] Economic Impact on Afghanistan-Pakistan Relations [https://gasam.org.tr/economic-impact-on-afghanistan-pakistan-relations/]
[5] The India-Pakistan Clashes Took an Economic Toll on Afghanistan [https://thediplomat.com/2025/05/the-india-pakistan-clashes-took-an-economic-toll-on-afghanistan/]