24.10.23 Middle East Review

The Gaza Effect: The economic ramifications of the new war in the Middle East will determine the course of ground operations and the response of neighbouring states

The Arab-Israeli military conflicts of recent decades have yielded varying economic effects: in 2006, the conflict triggered a sharp spike in oil prices, while in 2014, it had minimal impact on the economy. As it stands, the Israeli Central Bank is forecasting a slowdown in the country's growth from 3% to 2.3%. However, it is still unclear what the international consequences of the ground operation in the Gaza Strip, which could draw neighbouring states into the conflict, might be. Analysts from Bloomberg Economics have modelled three scenarios for the course of events and their economic repercussions. The most perilous scenario envisions a direct confrontation and exchanges of blows between Israel and Iran. In this scenario, not only Israeli but also global economies are highly likely to plunge into a recession, with the price of Brent crude oil rising to over $150 per barrel. However, so far, this scenario appears to be the least realistic. The other two scenarios appear more likely: in the first, the combat actions stay confined within Gaza; in the second, Lebanon and Syria are affected, while Iran also supports armed groups hostile to Israel. In the first case, oil prices will rise by $3–4 in the medium term and global GDP growth will lose 0.1 percentage point. In the second case, the losses to the global economy will rise to 0.3 percentage points, with oil prices increasing by approximately 10% or more.

To date, the impact of the Arab-Israeli conflict on the world economy appears limited. The war is creating tension in the oil and gas markets, as Re:Russia has previously noted. Undoubtedly, this will impact Israel's economy, which has been gaining momentum in recent years, largely thanks to the country’s technological sector. However, this prosperity was already significantly undermined by the domestic political conflict that has engulfed the country under the leadership of Benjamin Netanyahu's government. The current military conflict has led to an outflow of investment, a 5% depreciation of the shekel to date, a decline in tourism, which contributed 5.5% to Israel's GDP before the pandemic, and was projected to return to 4.3% this year, as The Financial Times has reported. Lastly, the call-up of 360,000 reservists has dealt a significant blow to the labour market. The Bank of Israel has lowered its expectations for Israeli economic growth this year to 2.3% (down from 3%), Bloomberg reports. Nevertheless, the Israeli economy is relatively resilient to local wars. Experts often refer to the 50-day war with HAMAS in 2014, which had virtually no impact on the economy. In contrast, the 2006 war triggered a sharp rise in oil prices.

However, any and all estimates of the economic consequences of the war are currently highly speculative. The main mystery surrounds Israel's ground operation in the Gaza Strip and the potential response to it by surrounding countries. Israel has shown that it is likely to launch the operation in the near future, despite US efforts to deter it. The alleged bombing of the Baptist hospital in the Gaza Strip has demonstrated that the bloody course of the ground operation could have unpredictable consequences in the region and draw new forces into the war in one form or another.

The analysts at Bloomberg Economics have modelled three possible scenarios for the escalation of the war in the middle east, with even the least severe scenario promising a slowdown in global GDP growth. The most dangerous escalation scenario involves Iran being drawn into the conflict. No one in the region, including Iran itself, would want this, but the risk is real, Hassan Al Hassan, a staff member of the International Institute for Strategic Studies (IISS), argues in conversation with Bloomberg. The likelihood of such an event has been heightened by events in recent months that have exposed Iran’s increased military capabilities and strengthened military cooperation with Russia, while improving relations with the US and Saudi Arabia.

As Re:Russia has reported, in 2023, the United States relaxed its sanctions on Iran to allow for increased oil exports, offsetting the effects of reduced oil production in Saudi Arabia and Russia. Several months ago, Iran reestablished its diplomatic relations with Saudi Arabia, which had been severed in 2016 after the attack on the Saudi embassy in Tehran. While there has not been any conclusive public evidence, some Israeli officials have not ruled out the possibility that Iran, if not directly involved in planning the HAMAS attack, had prior knowledge of it and provided strategic support for its execution. However, Israel views Iran's nuclear program as the primary threat, as the international community has fewer tools to thwart it,

Given that the Persian Gulf provides about 20% of the world’s oil supply, if Israel and Iran were to engage in mutual hostilities, economists from Bloomberg forecast that the price of a barrel of Brent crude oil could rise to $150, more than one and a half times its current price. This is a price surge on par with that of 1990 when Iraq invaded Kuwait. Furthermore, the conflict poses a threat to the uninterrupted passage of tankers through the Strait of Hormuz, through which 20% of the world's oil supplies and 25% of global liquefied natural gas (LNG) deliveries pass.

A direct confrontation between Israel and Iran would further exacerbate tensions between superpowers. The United States is a key ally of Israel, while China has deepened its relations with Iran in recent years. This new geopolitical conflict could expedite the fragmentation of the global economy, which experts from the International Monetary Fund (IMF) and other international organisations see as one of the primary risks to global economic growth. In the event of a direct confrontation between Israel and Iran, global GDP would be deprived of one percentage point of growth in 2024, which is equivalent to roughly $1 trillion. As a result, growth will be only 1.7%. With the exception of periods of global economic crises and the COVID-19 pandemic, this would be the worst result since 1982 when the sharp deceleration of the global economy was caused by US financial authorities' efforts to combat inflation resulting from the oil crisis triggered by the Yom Kippur War. In this scenario, global inflation would reach 6.7%. The Bloomsberg economists believe that rising gasoline prices in the United States would also likely hinder Joe Biden's re-election efforts.

However, the other two scenarios modelled by Bloomberg appear more likely. In the first, the military operations will remain confined within Gaza; in the second, Lebanon and Syria are affected, while Iran supports armed groups hostile to Israel. In the first scenario, oil prices would increase by $3-4 per barrel of Brent. This would be the effect of the tightening of American sanctions against Iranian exports. In this case, global GDP growth would lose 0.1 percentage point of its value. If 'Hezbollah' becomes involved in the conflict, the market would view this as a proxy war and would increase the risk premium associated with the danger of attacks or accidental damage to vital facilities. Oil prices would rise more significantly, by $10. In such a scenario, global GDP growth in 2024 would be 2.4%, 0.3 percentage points lower than the previous Bloomberg Economics forecast.