Markets are anticipating that the conflict will be contained. A wider Middle East war would hit an already fragile and fragmented economy.
Almost exactly 50 years since the start of the Yom Kippur War, Benjamin Netanyahu declared that Israel was at war again — this time with Hamas, the Palestinian group that governs Gaza.
The Israeli prime minister’s promise that “the enemy will pay an unprecedented price”, as well as the West’s failure to call for de-escalation sooner, have stirred concerns of a wider conflict in the Middle East. This is as growing tensions threaten to draw in major oil producer Iran, which has warned that political solutions to avoid a regional conflict are running out.
If a war in the Middle East does materialise, its impact will be felt as the spectre of Russia’s assault on Ukraine continues to haunt the global economy. Still-slow growth could stall and inflation’s downward trend may be reversed, as the echoes of the Yom Kippur War linger.
It was not too long ago that Russia induced the biggest energy shock since the 1970s oil crisis, brought on by America’s reaction to the Yom Kippur War between Israel and a coalition of Arab states and later instability in the Middle East — the largest oil-producing region in the world.
In the wake of the 1973 war, US president Richard Nixon ordered an airlift of military supplies to Israel, which America considered an ally during the Cold War.
In a bid to put pressure on the West to force Israel to withdraw from occupied land, the Arab members of the Organisation of the Petroleum Exporting Countries announced a 25% output cut and eventually banned the sale of oil to the US and the Netherlands. The embargo caused the price of a barrel of oil to quadruple by 1974.
The 1973 oil embargo featured in the International Monetary Fund’s World Economic Outlook, which sought to make sense of Russia-inflicted commodity market fragmentation.
Released last week, the report noted: “For the first time since the 1970s, commodities such as crude oil, natural gas and wheat were broadly used to exert pressure in a major conflict. Exports were restricted and counter sanctions imposed. These disruptions in commodity trade contributed to surging inflation in 2022 in many parts of the world, food insecurity in low-income countries and slower global growth.”
“While commodity prices have since normalised,” the report added, “geopolitical tensions signal that more severe fragmentation of commodity trade is a major risk.”
Russia’s war on Ukraine, and the sanctions and other supply constraints that followed, caused oil prices to hit a high of $116 per barrel in June 2022. Despite having fallen significantly since then, oil prices continue to be marked by considerable volatility.
Meanwhile, central banks fought inflation through successive interest rate hikes, risking tipping their economies into recession. They have since seemingly adopted a higher-for-longer approach to interest rates, a fact which looks to dampen growth over the medium-term.
According to the IMF’s report, the global economy’s growth is recovering — albeit well below the historical average — after Russia’s onslaught. And, after a particularly severe tightening cycle, inflation now seems to have been brought to heel.
That said, low growth and high interest rates suggest the global economy is still fragile, a predicament which could worsen in the midst of another Middle East conflict.
But markets are not currently pricing in this scenario, according to economists.
“The market is pricing in a contained war which stays within Israel and Palestine and maybe spills into parts of the Middle East,” Momentum Investments economist Sanisha Packirisamy said earlier this week.
Isaah Mhlanga, chief economist at Rand Merchant Bank, agreed. He noted that oil prices increased by about 7% following the outbreak of the war, but have since declined somewhat.
However, the risk of a Middle East-wide war still exists, given that both sides seem to be doubling down, Mhlanga added. “They are not de-escalating. They are even preparing to escalate the war, which means we can assume that it is likely to last much longer,” he said.
“And the longer it lasts, the higher the likelihood that another major country in the Middle East will get involved, or be drawn into the war. This might unsettle energy markets.”
Higher fuel prices will be a tax on growth, particularly in Europe, Mhlanga noted. “But also for all other major emerging markets that are oil importers, such as South Africa.”
Israel and Iran risk
Packirisamy said that the biggest risk is that the war sees Israel and Iran coming head-to-head.
Earlier this week, Iran’s foreign minister Hossein Amir-Abdollahian tweeted that a wider war was becoming unavoidable. Iran’s participation in the war could see the country closing the Strait of Hormuz, an important route for oil tankers from the Persian Gulf — which produces approximately 33% of the world’s oil.
Closing the strait would push oil prices above $150 per barrel, Packirisamy said. “That would have great repercussions for inflation, as well as for global growth. In the most severe scenario out there, we could potentially get to a global recession, especially given that growth is still quite fragile … So if this conflict does spillover and becomes a Middle East-wide issue, then you could get that risk scenario playing out.”
Packirisamy noted that there is also the possibility that the US and China will become involved, a prospect which would exacerbate geo-economic fragmentation — an outcome that the IMF has warned would hurt economic growth in the long run.
China, which has long backed the Palestinian cause, has deepened its ties with Iran, which was recently also included in the expanded Brics alliance alongside other key oil producers. China’s foreign minister Wang Yi reportedly said this week that Israel’s airstrikes on Gaza had gone “beyond the scope of self-defence”.
If geopolitical stability is rocked again, the question becomes how South Africa will avoid diplomatic landmines and mitigate against potential economic risks.
Packirisamy underlined the need for greater coherence when it comes to articulating South Africa’s stance on foreign affairs. “It’s going to be critical for us to maintain our role on the international stage, particularly with things changing as fast as they are … We’ve got all the components in place, but we have to speak from the same hymn sheet.”
Given the potential impact of global fragmentation on trade, Mhlanga said that South Africa’s strategy to navigate these troubled seas could be far clearer.
Fragmentation jeopardises trade, Mhlanga noted. “If countries are imposing restrictions on each other, in part because relations have soured, it implies that trade will be low and economic growth will also be low.”
Mhlanga pointed to India as an example of a country that has actively sought to strengthen trade ties amid the current global realignments. “If you look at India, it is very clear that they are going to align on the basis of economic benefits, not necessarily on the basis of ideology. We don’t have something as clear as that.”