The world had barely recovered from the COVID-19 pandemic and its severe economic consequences when the Russian-Ukrainian war erupted, leading to disruptions in supply chains and triggering multiple waves of inflation. Attempts to contain inflation were even more painful as the cost of capital rose globally, and investments became an unbearable burden. Developing countries are now chained by more expensive and rare sources of finance so that the main global growth engine is at risk of slowing down. These cascading crises came with the headwinds of global warming, regional conflicts, de-globalization, and trade wars. Amid all this, it is hard to imagine a spark of another war to be ignited in the already disturbed Middle East.

Risk of Global Recession

As Israel's declared war against Hamas escalates, there is a growing risk that the global economy could enter into a severe recession. Israel and its Western allies are almost certain that Hamas has received support from Iran to commit its latest attacks on October 7, 2023, which could drag the region into a broader multi-nation conflict that could potentially derail markets. It is evident that other neighboring countries are already engaged in the battlefield, as the Iranian-affiliated factions in Syria and the Lebanese Hezbollah are exchanging fire with the Israeli army on a daily basis.

Given this context, armed conflicts usually cast a shadow on the supplies and prices of various energy products, whose contagion spills over to the prices of other goods and services by raising the cost of transportation, storage, heating, cooling, water supply, and irrigation... among other components, that leave no single commodity spared from price inflation. According to the IMF’s estimates, a 10% increase in oil prices reduces global GDP by about 0.2% and raises inflation by 0.4%[i].

Global growth for 2023 is forecasted at 2.9% (down from 3% in July). These forecasts, however, do not take the new war into account. The main news is that global growth remains at around 3% in the next few years, well below what it used to be a couple of decades ago, around 3.8%. Among the major causes of this slowdown are a globally aging population and a weakening productivity growth. 

The new war also affects the expectations of trade, tourism, and capital flows in the entire region, especially under the pessimistic scenarios of escalation. Regional mega projects shall be at risk of being “put on hold” if the Israeli side insists on escalation. Any project intersecting with the “Road and Belt” initiative in the region shall be bearing a higher risk premium.   

Potential Turbulence in Oil Prices and MENA Growth

When the Gaza war broke out, oil prices hiked 4% (above USD 92 per barrel for Brent crude), and price forecasts rose above USD 100 per barrel. Commodity analysts say if the war escalates, prices could rise above the forecasted benchmark and remain selling at a remarkable premium if Iranian supply falls.

Iranian oil exports have risen in recent years, filling a gap that was left after Russia's invasion of Ukraine and under what some argue is a softer approach to sanctions under the Biden Administration. According to some estimates, Iran has made about USD 80 billion in illicit oil sales since Biden took office. If the war spreads further and Washington imposes tougher restrictions and sanctions on Iran, oil production of more than 3 million barrels a day could come under pressure (Iran’s oil exports estimated at 1.5 million barrels a day in August 2023). There is also a risk that Iran could disrupt the flow of oil through the Strait of Hormuz, where 20% of the world's oil is shipped through. If Iran's oil supply is cut, a key question is whether other oil producers may help fill the Gap or not. 

If the US sanctions on Iran are toughened, and there is no other substitution for Iranian oil supply, prices could easily sell through USD 100; that is going to add to inflation pressure globally, which in turn adds further pressure on central banks to keep raising interest rates and maximize the risk of a global recession. If tensions continue to escalate, we could be driven towards a long period of economic uncertainty.

MENA region’s economy was forecasted to slow down in 2023, with the GDP growth plummeting to just 1.9% down from 6% in 2022.[ii] The extraordinarily rapid growth in 2022 was boosted by the surge in oil prices. This surge might be reproduced under the wider war scenario, reviewing economic growth forecasts in the region at a slightly higher pace than 1.9%. The effect of surging oil prices will be only limited to the last quarter of the current calendar year. 

The Palestinian Economy 

While writing these words, the death toll in Gaza has reached more than 8000, as reported by the de-facto government of the strip. The number of victims is highly expected to increase, as cease-fire demands were vetoed multiple times by the United States in the United Nations Security Council. Following the recent Israeli evacuation order of northern Gaza, the United Nations Relief and Works Agency (UNRWA) indicated that it is no longer in a position to consider its premises to remain protected. 

According to an official statement by the UNRWA on October 22, 2023: “UNRWA is currently hosting more than half a million people out of nearly 1 million displaced across the Gaza Strip.” the statement adds, “In three days, UNRWA will run out of fuel, critical for our humanitarian response across the Gaza Strip.”[iii]

Prior to the war, GDP in Palestine was expected to reach USD 17.96 Billion by the end of 2023, down from USD 19.11 billion in 2022, according to Trading Economics global macro models. These expectations will certainly be revised downwards, given the current developments. In 2022, GDP growth rates for the West Bank and Gaza Strip recorded a decline of 3.93% and 3.08% respectively.[iv]

The unemployment rate in Palestine hit 24% in 2022, and the total labor underutilization reached 31%. However, there is still a significant gap in unemployment rates between the West Bank and the Gaza Strip, as this rate reached 45% in the Gaza Strip compared to 13% in the West Bank.[v]

The United Nation says that more than 80% of Gaza residents live in poverty,[vi] with no access to clean water and electricity even before the latest blockade and attacks. Israel has imposed a full land, sea, and air siege on the Gaza Strip since 2007, hindering the transfer of people and goods and striking the economy harshly.

The Israeli Economy

The Israeli Real GDP has reached USD 525 bn in 2022; it was expected to decline to USD 522 bn (as per the IMF) by the end of 2023. The latest figure should now be downward reviewed. The Israeli defense forces called up 300,000 reservists for duty; they are now out of the economy, deprived of adding any value to the productive labor forces. Another challenge to the Israeli economy is the loss of tourism, which is imminent and depends on how long this war is expected to go on. In 2022, the income from tourism to Israel surged to USD 5.5 bn (more than double tourism’s revenues in 2021). 

The Israeli Real GDP has reached USD 525 bn in 2022; it was expected to decline to USD 522 bn (as per the IMF) by the end of 2023. The latest figure should now be downward reviewed. The Israeli defense forces called up 300,000 reservists for duty; they are now out of the economy, deprived of adding any value to the productive labor forces. Another challenge to the Israeli economy is the loss of tourism, which is imminent and depends on how long this war is expected to go on. In 2022, the income from tourism to Israel surged to USD 5.5 bn (more than double tourism’s revenues in 2021). 

The credit rating of Israel for long-term and short-term debts is quite attractive, as it ranges between an AA and a single A rating through the big three credit agencies (Moody’s, Fitch, and S&P). However, only recently, S&P changed the outlook to negative, given the context of the new conflict. This means a likely credit downgrade in the upcoming review. Moody’s also announced that the A1 rating to Israel is at risk of downgrade, as the CDS (Credit Default Swaps) for the Israeli sovereign debts are selling 80% higher since the outbreak of the war. The higher the CDS prices, the higher the likelihood of the default risk assumed by the investors, as these swaps are used mainly to hedge credit risks.       

Furthermore, Israel also depends on the exports of natural gas to Europe through Egypt and Jordan. On the first day of the air strikes, Israel decided to halt the Egyptian pipeline for security reasons. Natural gas is liquefied in “Idku” and “Damietta” plants in the northern delta of Egypt to be exported to European countries to partially fill the gap of the Russian gas shortage. These liquefication plants are installed with a capacity of 12 million cubic meters annually. Israel can export more than 9 million Cubic meters/year, but it cannot sustain this pattern during wartime.

Another challenge is that Israel is the home of many multinational companies. It used to incubate a sum of 387 active multinationals in 2020, most of them in IT and enterprise Software[vii]. These companies usually raise red flags during armed conflicts; they lose momentum and call foreign employees to evacuate when possible. There are 110 Israeli companies currently listed and traded on the US stock market (mainly NASDAQ exchange), with a total value of USD 140 bn[viii]. These investments will likely witness a heavy strike in market capitalization if the war prolonged.  

The Water Conflict

It is not possible to look at the repercussions of the unstable situation in the eastern and southeastern Mediterranean without looking at some of the root causes of the historical tension related to the water conflict. The current pattern of water distribution between the Israeli and Palestinian sides reflects an asymmetric distribution of control and use. While the share of the Palestinian citizens is less than 100 liters of water per day for residential use, the share of the Israeli citizens, including settlers, is more than three times this amount. It should be noted here that more than 20% of Palestinians are not connected to drinking water networks, which makes them more dependent on the most expensive water tanks, which make them bear one of the largest water bills in the region.

Israeli water policy is aware of the decline in the per capita share of renewable natural water sources, from around 504 cubic meters in 1967 to only 98 cubic meters in 2015, the year in which the total demand for water in “Israel” reached 2.2 billion cubic meters annually, while the annual average amount of water flowing into the Sea of Galilee, during the ten years preceding this date, is slightly less than 1.2 billion cubic meters/year.

There is, therefore, a large gap between the demand and supply of natural water sources, amounting to about one billion cubic meters. Israel was able to bridge this gap in a stable and sustainable manner by providing water recycling and desalination in excess of one billion cubic meters annually. Yet, the ongoing war today, which is likely to expand and continue, will certainly affect the environmental situation and deepen water scarcity, especially for the Palestinian side, which is deprived of establishing any infrastructure projects to address the issues of water scarcity and pollution in the West Bank or from any attempt to control the already limited share of water in the West Bank and Gaza Strip. 

Israel is also awaiting a possible targeting of water desalination and recycling projects, which have cost it billions of dollars in investments and whose capacity decline or termination of operation, even partially, represents a direct threat to the Israeli security theory and to the settlement project based on increasing the agricultural area on Arab lands, and make them habitable for the largest possible number of Jewish immigrants.

It is too early to make precise estimates for the global and regional economic impact of the war in the occupied lands. Escalation of this war increases the odds of economic recession, accompanied by higher inflation rates. A combination that is known as “stagflation,” the worst nightmare for any economist.