Will the Middle East wars spiral into a global economic meltdown?

It has been over a year since the tragic attack by Palestinian groups on Israel on October 7. During this time, the conflict has expanded significantly, affecting not only Israel and Gaza, but also neighboring countries, particularly Iran.

Ground operations, strikes on civilian infrastructure, and prolonged military actions, including direct exchanges between Iran and Israel, have worsened the humanitarian situation in the region.

The international community has made repeated attempts to mediate the conflict, but efforts for peaceful dialogue have yet to yield meaningful results. The conflict has also heightened political tensions, drawing in more neighboring states and creating a risk of a broader international crisis.

The economic consequences have become evident not only for Israel but for the global market as well. Expectations of rising oil prices due to regional instability continue to grow, further exacerbating inflationary pressures on the global economy. In Israel, GDP growth has slowed significantly, and investors are wary of engaging in new projects, not only in the country but throughout the region.

Forecasts by Israel’s central bank regarding an economic slowdown have proven accurate. Economic activity in the country has declined, foreign investments have stalled, and inflation has surged due to a sharp increase in oil prices.

As the world anxiously watches the unfolding events, analysts predict three potential future scenarios. The most dangerous involves a direct confrontation between Israel and Iran, which could lead to a global recession and push oil prices to $150 per barrel. However, more likely scenarios involve the conflict remaining contained within Gaza, Lebanon, and Syria, which would still result in significant oil-price hikes and further strain the global economy.

Israel’s economy is facing one of its toughest tests in recent years. The country is experiencing the steepest slowdown among the wealthiest nations of the Organization for Economic Co-operation and Development (OECD). Amid these challenges, the Israeli economy was further hit by a nationwide strike on September 1, which briefly brought economic activity to a near halt due to widespread dissatisfaction with the government’s handling of the war.

Although Israel’s economic troubles are not comparable to the devastation in Gaza, the prolonged war continues to harm the country’s finances, reduce business investments, and erode consumer confidence. Before the war, Israel’s economy had been growing rapidly, largely driven by the tech sector. In 2021, per capita GDP rose by 6.8%, and in 2022, it increased by 4.8%, far outpacing most Western countries. 

Israel’s economic indicators for the second quarter of 2024 are alarming. GDP for the April to June period grew by only 1.2% year-over-year, a 1.4% decrease compared to the same quarter last year. This result was well below economists’ expectations. They had forecast growth in the range of 2.3% to 5%. Adjusted for population growth, per capita GDP fell by 0.4% in the second quarter, signaling a slowdown in economic growth as the ongoing war continues to heavily impact exports and investments.

Ronen Menachem, the chief economist at Mizrahi-Tefahot Bank, noted that the decline in per capita GDP compared to both the previous quarter and the same period last year is a clear indication of the significant damage the protracted conflict has inflicted on the Israeli economy. Additionally, in the second quarter, business production shrank by 1.9%, while exports of goods and services fell by 8.3%. However, amid these negative indicators, private consumption – one of the key drivers of economic activity – increased by 12% in the second quarter, following a robust rise of 23.5% in the previous quarter.

The war has also severely impacted specific sectors of Israel’s economy. The construction sector slowed by nearly a third in the first two months of the conflict, while agricultural production decreased by a quarter in several regions. Approximately 360,000 reservists were mobilized at the war’s onset, although many have since returned home. More than 120,000 Israelis were forced to leave their homes in border areas, and 140,000 Palestinian workers from the West Bank were barred from entering Israel following the October attacks.

To address the labor shortage, the Israeli government is recruiting workers from India and Sri Lanka; however, a significant number of vacancies remain unfilled. It is estimated that up to 60,000 Israeli companies may close in 2024 due to a lack of personnel, supply chain disruptions, and declining business confidence, with many companies postponing the launch of new projects. While tourism is not a key sector of the Israeli economy, it has also suffered. The influx of tourists has sharply declined since the onset of the war, and one in ten hotels in the country faces the threat of closure.

Meanwhile, forecasts for Israel’s economic growth have worsened. In July, the Bank of Israel revised its expectations, lowering the growth forecast to 1.5% for 2024, down from a previous projection of 2.8%. In light of ongoing hostilities in Gaza and escalating conflict with Hezbollah along the Lebanese border, the Bank of Israel estimated that the total costs of the war could reach $67 billion by 2025. Even with a US military aid package of $14.5 billion, the Israeli economy may struggle to cope with these expenses.

This situation necessitates complex decisions regarding resource allocation. There may be a need to cut funding for certain sectors of the economy or to increase borrowing. However, higher debt levels would lead to increased loan repayments and a rise in servicing costs in the future. The deterioration of the fiscal situation has also led to a downgrade of Israel’s credit rating. In August 2024, Fitch Ratings lowered the country’s rating from A+ to A, citing rising military expenditures that have increased the budget deficit to 7.8% of GDP in 2024, up from 4.1% the previous year. This could jeopardize Israel’s ability to maintain its current military strategy, which requires significant financial resources for operations in Gaza, including the use of advanced weaponry and logistical support.

Economic activity in Gaza has virtually ceased. Trade has come to a standstill, and many Palestinians now rely on humanitarian aid. Meanwhile, vital communication channels have been severed, and key infrastructure has been destroyed due to ongoing combat and bombardments.

The effects of the war have extended far beyond Israel and Palestine. In April, the International Monetary Fund (IMF) projected weak economic growth for the Middle East region in 2024 – only 2.6%. The primary reason cited was the uncertainty stemming from the conflict in Gaza, as well as the threat of the conflict escalating into a broader regional crisis.

This is not the first time that violence in Gaza has had a global economic impact. For instance, Israel’s bombing of Gaza in 2008 led to an almost 8% spike in oil prices, raising concerns in global markets.

The conflict in the Middle East, particularly between Israel and Iran, could have serious implications for the global energy market. One of the most vulnerable points in this geopolitical tension is Iran’s oil infrastructure. In the event of an Israeli attack on Iran’s oil facilities, prices could surge past $100 per barrel. Iran currently produces over 3 million barrels of oil per day, exporting about half of this amount, primarily to China. Consequently, any reduction in exports would create a supply shortage in the global market, inevitably driving up prices.

Strikes on key oil infrastructure, such as the main export terminal on Kharg Island, pose a significant threat to the market. This terminal is strategically vital for Iran’s oil exports, and its incapacitation could drastically reduce supply volumes, exacerbating global shortages and causing chaos in the markets. It is worth noting that amid rising global tensions, other exporting countries may not be able to promptly compensate for the losses, further aggravating supply and demand issues for energy resources.

Moreover, the potential for Iran to close the Strait of Hormuz, through which approximately 20% of global oil supplies pass, could have catastrophic consequences for the world economy. The strait is a crucial transport corridor for oil from the Persian Gulf countries, and its blockage would lead to shortages not only of Iranian oil but also of Saudi, Kuwaiti, Emirati, and other key producers’ oil.

It is important to consider that the impact of an attack on Israeli oil infrastructure is likely to be limited, as Israel is not a major player in the global oil market. However, the political and military ramifications could be significant. The threat of a full-scale conflict in the region would contribute to long-term instability, not only in the energy sector but also in global financial markets.

The situation is further complicated by the political interests of other global players. The US, on the brink of presidential elections, will strive to stabilize the global economy and avoid spikes in oil prices, as rising prices could lead to inflation and pressure on the domestic market. Therefore, the US administration may seek to alleviate tensions in the region, possibly through diplomatic channels and increased oversight of the situation.

The influence of this conflict on the energy market will directly depend on how far Iran and Israel are willing to go with their threats. Should the confrontation escalate to actual strikes on critical energy infrastructure, the world could face significant turbulence in the energy markets, potentially resulting in long-term consequences for the global economy, including sharp fuel price increases and disruptions to supply chains.

The conflict in the Middle East, particularly between Israel and Iran, poses a serious threat not only to the oil market but also to the gas sector. Based on official statistics, one can expect that an escalation in the situation could lead to significant upheavals in the energy markets, as this region plays a pivotal role in the global energy system.

According to the International Energy Agency (IEA), Iran produced approximately 256 billion cubic meters of natural gas in 2022, a substantial portion of which is directed toward domestic consumption. However, Iran also exports gas to neighboring countries such as Türkiye, Iraq, and Armenia. In the event of attacks on Iran’s energy infrastructure or a blockage of the Strait of Hormuz, which is crucial not only for oil transportation but also for liquefied natural gas (LNG) exports, the global gas market could become extremely unstable.

For the global economy, such upheavals may trigger chain reactions. A sharp reduction in supply and potential disruptions in gas deliveries would lead to rising prices for this energy resource, impacting importing countries, especially in Europe. In 2022, according to Eurostat, nearly 40% of the natural gas supplied to Europe came from Russia. However, following sanctions imposed in the wake of the Ukraine crisis, many countries began seeking alternatives, including supplies from the Persian Gulf and the US. If gas supplies from Iran were to cease, this would exacerbate shortages in the European market, potentially leading to a new wave of energy crisis during the winter months, when demand for gas for heating significantly increases.

Moreover, such events could hinder the implementation of LNG projects, both in the Persian Gulf region and elsewhere around the world. For instance, Qatar, one of the largest LNG exporters, transports its gas through the Strait of Hormuz. Any disruptions in this region would lead to decreased LNG supplies to global markets and rising gas prices in Asia and Europe. This would be particularly felt by countries already facing energy resource shortages, such as Japan, South Korea, and China. 

At the same time, rising gas prices will have repercussions for industry, especially in sectors dependent on gas supplies, such as chemicals, fertilizers, metallurgy, and power generation. Increased energy costs will raise production expenses, intensifying inflationary pressures in the global economy. According to the International Monetary Fund (IMF), global economic growth is projected to slow to 2.6% in 2024, and the energy crisis could further worsen this outlook.

Rising energy prices will also contribute to inflation in consumer segments. According to the OECD, global inflation reached 6.6% in 2023, and a sharp increase in oil and gas prices could once again drive up the costs of essential goods and services, negatively affecting consumer purchasing power. The transportation sector will experience particularly strong pressure, as fuel costs are a key element of overall expenses. 

Thus, the escalation of the conflict in the Middle East will have severe consequences for the oil and gas markets, leading to rising energy prices and inflation. The global economy will face new challenges that will require coordinated actions from major players to stabilize the situation and seek alternative sources of energy supply.