How the Israel-Hamas conflict could disrupt the World Economy and worsen trade relations?

In the heart of the Middle East, the longstanding conflict between Israel and Hamas has, this time, erupted into a full-fledged destructive warfare taking the lives of 1400 Israelis, 11,500 Palestinians, and counting. As the violence escalates, the world watches with bated breath, cognizant of the potentially far-reaching consequences.

How long and how far the war will go? Is it going to polarise the world into two? What are the chances of the other nations getting involved? How much will it cost to the world? This report explores the broader economic implications of this conflict on a global scale, shedding light on how it could threaten the global economy, disrupt key trade routes and supply chains, and drive energy prices up.

The economic crisis in the warzone’s neighbouring countries, Egypt, Jordan, and Lebanon, is likely to and may result in the collapse of the governments.

“You look at the neighbouring countries Egypt, Lebanon, Jordan there the channels of impact are already visible,” Kristalina Georgieva, the IMR chief, said at FII, the Future Investment Initiative in the Saudi’s capital Riyadh.

 “What is happening in the Middle East is happening at a time when growth is slow and interest rates are high and cost of servicing debt has gone up because of COVID and war,” Ms. Georgieva talked about how multiple interrelated factors could kill industries and economic growth in the region.

Oil accounting for around 40 percent of the world energy mix rules the world economy and any sharp bounce in oil prices can trigger recession. The Middle East being the epicentre of oil-producing countries with major players like Saudi Arabia, Iran, and Iraq contributing 30.7 million barrels per day holds significant sway over international energy markets. What happens in the region has direct consequences on the cost of crude. The Israel-Hamas conflict raises concerns about potential disruptions in international oil prices.

Buzzing with 20% of global seaborne trade, the Middle East is the hub of the world’s busiest sea-routes due to its favourable geographic advantage and massive investments. The network includes the Red Sea, the Suez Canal, the Persian Gulf, and the Strait of Hormuz for both oil and non-oil world trade. Almost 15% of global trade, 45% of crude oil, 9% of refined, and 8% of LNG tankers transit through the Suez Canal. You can imagine how the blockage in the sea routes will disrupt the whole world’s supply chain for oil as well as non-oil trades and cause delays in the delivery of goods and raw materials to import-reliant nations.

Global financial markets that do act on the whims and fancies of the geopolitical forces are now waiting and watching what side the other nations of the region will turn to. If it remains only between Israel and Hamas, the impact will be limited to the countries that have direct trade exposure to them. However, if the conflict spreads to major oil-producing nations in the region such as Iran, the global economy could face severe repercussions as energy costs for businesses and households could spike if supply is interrupted.

Revising history gives insight into the subject. The infamous Yom Kippur War in October 1973 between Arab- Israel triggered (Arab nations of) OPEC to impose an embargo on the West. OPEC cut oil production by 25% and raised its price by 70% resulting in the massive oil crisis in the West had a spiralling impact – spiked inflation, high unemployment, and finally culminated in global economic downturn.  

In 2006, prices spiked globally due to the Israel and Hezbollah clash in Lebanon, with the same fear of spreading of the conflict to the region.

History may or may not repeat itself, but international agencies have taken cognizance of the impending threat. On 24 Oct, S&P Global downgraded Israel’s outlook from stable to negative. “The negative outlook reflects the risk that the Israel-Hamas war could spread more widely or affect Israel’s credit metrics more negatively than we expect”, asserts the credit ratings agency. And there is a basis to it. “The direct cost of Israel’s war on Gaza was about 1 billion shekels ($246m) a day,” Bezalel Smotrich, Israel’s Finance Minister admitted last week.

The war has already caused oil prices to climb over fears that it could embroil the wider petroleum-producing Gulf region and threaten global output. Consequently, prices have climbed to $90 a barrel and international crude oil prices have risen over 5 percent.  

In extreme circumstances, economists are anticipating the Brent to go over $100 per barrel and linger for a long time, resulting in a rise in inflation, slower economic growth, and a downward spiral impact on the world economy pushing it towards global recession.

With the increase in oil prices, the cost of production for industries and energy costs for businesses and households will also surge, driving global inflation higher. The oil-dependent countries will see substantial import inflation, increasing the vulnerability of industries heavily reliant on Middle Eastern resources, such as petrochemicals and manufacturing.

Meghnath Desai, Emeritus Professor of Economics at the London School of Economics writing for OMFIF, an independent think tank, foresees “the war to be long drawn and transformed to regional conflict with Syria, Lebanon, Egypt, and Arab states getting embroiled and UN will not be able to contain it. Inflation will rise to double digits in Europe and the US and the oil will reach $150 and the world will enter recession.” He likened the Hamas-Israel conflict to the Russia-Ukrains e conflict, referring it to as two-states-within-one-territory problem not forseeing many breakthroughs.

Could it get worse or better?

Though Israel and Hamas think it is their localized struggle, it holds the potential to send shockwaves through the world economy. In the worst-case scenario, if it spreads, the conflict would lead the oil to go up to $150 per barrel, a 20% shock to international stock markets, sever global supply chains, bring investor confidence to rock bottom, and swipe $1 trillion off world production, culminating into the second Great Depression.  

Some doomsday theories are also going around, such as historian Niall Ferguson warned that the world is sleepwalking into an era of political and economic upheaval akin to the 1970s — only worse. How the pandemic, changing geopolitical scene in the world, Ukraine-Russia war, growing proximity of Russia with China, and now the Israel-Gaza war which is part of a bigger picture, are pushing the world to World War III.

But we hope. We hope for the better. Saudi Arabia and UAE are ambitious about their economic growth and should and would rather make efforts towards regional stability, at least not drag themselves into the embroil. China and Russia, without taking any sides, have supported a ceasefire proposal at the UN and called for peace.

The United Nations General Assembly (UNGA) passed a non-binding resolution calling for an immediate humanitarian truce between Israel and Hamas with 120 nations in its favour, including Saudi, Iran, UAE Jordan, Lebanon, and Egypt, clearly shows what the larger part of the world wants. And the world is hoping.