EconomyIssue 01 - 2024MAGAZINE
GBO_ Economy

Economy faces uncertainty amid war

Exchange rates, commodities prices, and stock market indices are all significantly impacted by internal and interstate conflicts

People’s perceptions of economic growth are frequently significantly shaped by geopolitical tensions on a global scale. According to research, worries about these kinds of problems can make people and companies more frugal with their money and investments, which can eventually result in a recession.

This also applies to the recent escalation of the conflict between Israel and Palestine. Concerns about the effects of this war are plaguing investors worldwide, especially in view of the already dire outlook for global economic expansion.

The latest episode in a decades-long cycle of violence in this region appears to have no end in sight, as evidenced by Hamas’s attack on southern Israel on October 7. The potential short- and long-term economic effects of the conflict are more obvious, despite the complexity of the reasons behind these events.

Ultimately, if the conflict between Russia and Ukraine has taught us anything, it is that we need to be aware of the complex interdependencies that influence the geopolitical and economic landscape of the world.

How conflicts can affect the economy

Exchange rates, commodities prices, and stock market indices are all significantly impacted by internal and interstate conflicts; in some cases, these conflicts even cause prices of commodities to rise prior to hostilities. However, evaluating the longer-term economic impact is usually more difficult. Even seemingly dramatic events can have long-lasting effects on investor behaviour that are difficult to forecast.

Middle Eastern conflicts frequently result in sharp increases in oil prices, examples include the 1973–1974 OPEC oil embargo, the 1978–1979 Iranian revolution, the 1980 Iran–Iraq War, and the 1990–1991 First Persian Gulf War. Since the region supplies almost a third of the world’s oil, any instability there could raise market apprehension due to worries about disruptions to the supply of oil worldwide.

The risk premium in the oil markets is a reflection of this uncertainty. In contrast to the current price of oil, this is the price paid for oil that is traded ahead of time in futures markets. It reflects the profits that traders hope to make from purchasing and disposing of oil during hostilities, as well as the hedging requirements and supply and demand worries of companies that produce and use oil.

Therefore, the participation of other significant regional powers will determine how the most recent Israel-Hamas conflict affects international financial markets. The impact of the ongoing conflict between Israel and Hamas is likely to be restricted and may even be exclusive to nations that have direct trade relations with either Israel or Palestine.

However, if the conflict extends to significant oil-producing countries in the area, like Iran, the world economy may suffer greatly because a disruption in supply could result in a rise in energy costs for both households and businesses.

The majority of developed and emerging economies’ central banks would find it more difficult to control inflation if energy prices rose. This could result in a “higher for longer” monetary policy that maintains high interest rates, which would increase the cost of borrowing and refinancing for individuals, businesses, and governments.

History can provide some understanding of how these various scenarios might affect the global economy. For example, the 2,200 people who died during the 50-day conflict between Israel and Hamas in 2014—the majority of them civilians—had no appreciable impact on the world economy or financial markets.

However, worries about a wider Middle East conflict caused oil prices to soar globally in 2006 when Israel and Hezbollah clashed in Lebanon.

What to expect

Unfortunately, there is currently another aspect to take into account. The realignment of various global alliances has coincided with the escalation of the Israel-Palestine conflict. One indication of this gradual ‘deglobalization’ is the change in trade policy in recent years.

Concerns about relying on suppliers in potentially hostile regions and the impact of low-wage imports on struggling local labour markets have led countries like the US and UK to relocate economic activity, including sourcing or manufacturing products from different countries.

These shifts are currently also evident in the responses to the Hamas attack on Israel. Almost everyone in the world supports the United Nations’ 1947 and 1974 reaffirmations of a two-state solution to the Israel/Palestine conflict.

However, there has been some variation in how the attack has been received internationally. As the majority of Western nations swiftly declared their support for Israel’s right to self-defence, nations like China and Russia called for a ceasefire without endorsing Hamas.

This implies that the Israel-Palestine conflict may be related to the larger trend toward the new geopolitical divisions that were beginning to take shape even prior to Hamas’s attack.

Extended hostilities between Israel and Palestine, particularly involving prominent regional powers, may expedite this global realignment and pose adverse effects on global economic expansion.

Investors are already preparing for more financial volatility in light of these conditions, expecting it to affect everything from government bonds and stocks to commodities markets. Gold and other so-called “safe-haven” assets are usually used as hedges against extreme economic uncertainty.

Following the most recent escalation in the Israel-Palestine conflict, the price of gold has skyrocketed. The financial markets will keep an eye out for any indications of escalation in the conflict between Israel and Hamas. Increased concerns about rising inflation will resurface in response to any increase in oil prices.

Unfortunately, after two years of consistently high consumer prices, this is occurring at the same time that inflation was beginning to slow down in many countries.

Shekel sees a downward trend

Following Fitch’s decision to place Israel’s A+ sovereign credit score on watch negative due to the increased risk of a significant escalation in the conflict with the Hamas terror group, which could result in a negative rating action, the Shekel and Tel Aviv continued its downward trend.

“The risk that other actors hostile to Israel, such as Iran and Hezbollah, could join the conflict at scale has risen significantly, as indicated by regular fire exchanges on the Israel-Lebanon border and declarations from high-ranking officials in Iran and from Hezbollah,” Fitch cautioned in a report, the Times of Israel reported.

“Such large-scale escalation, in addition to human loss, could result in significant additional military spending, destruction of infrastructure, sustained change in consumer and investment sentiment and thus lead to a large deterioration of Israel’s credit metrics,” the ratings agency warned.

This was the first time the Shekel has crossed the 4 to the dollar threshold since 2015, after Israel declared war on Hamas after some 2,500 fighters breached the heavily guarded Gaza border on October 7 and attacked Israelis. In response, Israel launched numerous airstrikes on Hamas targets and is getting ready to launch a ground operation in Gaza.

A lengthier and more extensive conflict involving numerous parties might result in a ‘sustained fiscal drain, both from higher spending and lower tax collection, as well as loss of human and material capital and severe economic disruption,’ according to a warning from Fitch in its report.

Assuming the conflict stays in Gaza, Israel’s economy is strong enough to bear the consequences in the current circumstances, according to Fitch.

“The combination of Israel’s dynamic, high-value-added economy, the record of resilience to regional conflict, preparedness for military confrontations, solid fiscal and external metrics and cash buffers make it unlikely a relatively short conflict largely confined to Gaza will affect Israel’s rating,” Fitch said.

The Fitch rating system goes from AAA to D, and the A+ is not the highest rating. An “A” rating indicates high credit quality, low default risk, and a strong ability to repay debts, but it also indicates some vulnerability to unfavourable business or economic conditions.

Along with Standard and Poor’s and Moody’s Investors Service, Fitch is one of the three major credit rating agencies, with offices in both New York and London.

As stated in an October 11 report, Moody’s issued a warning, stating that the Israeli economy, which has previously demonstrated resilience to both military operations and terrorist attacks, is likely to face difficulties in the coming months.

The ongoing Israel-Palestine conflict not only raises immediate concerns about regional stability but also has broader implications for the global economy. Geopolitical tensions, like those in the Middle East, historically affect key economic factors such as oil prices and investor behaviour. The conflict’s potential to escalate and involve significant regional powers adds a layer of complexity, impacting financial markets and currencies. The recent downgrade of Israel’s sovereign credit rating and warnings from rating agencies underscore the economic risks. As the world braces for increased financial volatility, the conflict’s resolution and its broader geopolitical impact will play a crucial role in shaping future economic landscapes.

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