- War puts pressure on people, businesses and countries at a time when public finances are already burdened by long-term problems. Higher energy and food prices, tighter financial conditions and greater uncertainty are once again prompting fiscal support activities, a group of experts from the International Monetary Fund’s research team (who lead the Research, Fiscal and Monetary Affairs and Capital Markets departments) recently estimated. The shock is global but asymmetric
The world is facing another shock. War in the Middle East (with the US, Israel and Iran as the main actors) is “disrupting lives and livelihoods” in the region and beyond. It also dampens the prospects for many economies that have just shown signs of sustained recovery from previous crises. War puts pressure on people, businesses and countries at a time when public finances are already burdened by long-term problems. Higher energy and food prices, tighter financial conditions and greater uncertainty are once again prompting fiscal support activities, a group of experts from the International Monetary Fund’s research team (who lead the Research, Fiscal and Monetary Affairs and Capital Markets departments) recently estimated.
The shock is global but asymmetric. Energy importers are more exposed than exporters, poorer countries more than richer ones, and those with scarce reserves more than those with abundant reserves. In addition to the high number of human casualties, the war in the Middle East has caused serious disruptions to the economies of the countries most directly affected, including damage to their infrastructure and industries, which could become long-lasting. Although these countries are resilient, their short-term growth prospects will be adversely affected.
Meanwhile, major energy importers in Asia and Europe are bearing the brunt of higher fuel and transit costs: about 25-30 percent of global oil and 20 percent of liquefied natural gas pass through the Strait of Hormuz, meeting demand not only in Asia but also in parts of Europe. Economies heavily dependent on oil imports in Africa and Asia are finding it increasingly difficult to access needed supplies, even at inflated prices.
Parts of the Middle East, Africa, Asia Pacific and Latin America face additional pressure from higher food and fertilizer prices and tighter financial conditions. Low-income countries are particularly vulnerable to food insecurity. Some may need more external support as aid is reduced.
All scenarios lead to higher prices and slower growth
Although war could shape the global economy in different ways, all paths lead to higher prices and slower growth. A short conflict could cause oil and gas prices to rise before markets adjust, while a long conflict could keep energy expensive and burden countries that rely on imports. Or the world “could settle somewhere in between – tensions continue, energy remains expensive and inflation difficult to control – with continued uncertainty and geopolitical risk,” IMF experts say. Much depends on how long the conflict lasts, how widespread it is and how much damage it causes to infrastructure and supply chains.
Energy is the main transmission channel. The de facto closure of the Strait of Hormuz and damage to regional infrastructure caused the biggest disruption to the global oil market in its history, according to the International Energy Agency. For fuel-importing economies, the negative impact is large. The multi-regional influence is obvious. Energy-importing economies in Africa, the Middle East and Latin America are feeling the pressure of higher import bills, on top of already limited fiscal space and external reserves.
In Asia’s major manufacturing economies, higher fuel and electricity bills are driving up production costs and reducing people’s purchasing power, while in some balance-of-payments pressures are already weighing on currencies. In Europe, the shock revives the picture of a 2021/2022 gas crisis, with countries such as Italy and the UK particularly exposed due to their dependence on gas, while France and Spain are relatively protected by their larger nuclear and renewable energy capacities.
By contrast, oil-exporting countries in the Middle East, parts of Africa and Latin America, which can still deliver their barrels of oil to the market, are benefiting from stronger fiscal and foreign trade positions due to higher prices. Producers whose exports are restricted or reduced – including several members of the Gulf Cooperation Council – can expect much lower growth. Even after transit resumes, higher risk premiums and uncertainty could limit investment and growth.
The most vulnerable will bear the brunt of the effects on supply chains
War also changes supply chains for non-energy and critical inputs. Rerouting tankers and container ships increases shipping and insurance costs and lengthens shipping times. Air travel disruptions around key Gulf hubs affect global tourism, while also adding another layer of complexity to trade.
In addition to higher commodity prices, countries, companies and consumers are already struggling with the consequences of these supply chain complications. With fertilizer shipments halted, about a third of which pass through the Strait of Hormuz, concerns about food prices are growing. The disruption to the Gulf’s supply of crop nutrients comes just as the Northern Hemisphere’s planting season begins, threatening year-round yields and harvests and driving up food prices.
The most vulnerable will bear the brunt. People in low-income countries are most at risk when prices rise, as food accounts for about 36 percent of consumption on average, compared to 20 percent in developing countries and nine percent in developed economies. This makes any increase in fertilizer and food prices not only an economic but also a sociopolitical problem, especially when fiscal resources to mitigate shocks are limited.
There may also be shortages or price spikes in other materials used in production. The Gulf supplies much of the world’s helium, which is used in a wide range of products from semiconductors to medical imaging devices. Indonesia, which supplies about half of the world’s nickel – a key component in electric vehicle batteries – could face a shortage of sulfur needed to process the metal. East African economies that depend on Gulf trade links and remittances are facing weaker demand for service exports, logistical bottlenecks and reduced remittances.
Risk of fueling inflation globally
If high energy and food prices continue, they will fuel inflation around the world. Historically, continued increases in oil prices tend to increase inflation and reduce growth. Over time, higher transportation and investment costs increase the prices of manufactured goods and services. For many countries that have just brought inflation closer to their target, and even more so for those with more stable inflation, this risks a renewed period of upward price pressures.
Here too, the pattern is uneven. In much of Asia and parts of Latin America, where inflation is relatively low, higher energy and food costs will test the resilience of expectations, especially in economies with weaker currencies and large energy imports. In Europe, another energy-driven price hike would come on top of existing cost-of-living pressures, raising the risk of tougher demands for wage increases. In low-income countries where people spend a large proportion of their income on food, particularly in Africa and parts of the Middle East and Central America, higher food prices carry acute social and economic costs.
If people and businesses in any of these regions believe that inflation will remain higher for a longer period, they may pass this on to wages and prices, making it harder to contain the shock without a sharper slowdown. Thus, war increases not only current inflation but also the risk that expectations become less firmly anchored.
The war disrupted financial markets. Global stock prices fell, bond yields rose in major advanced economies and many emerging markets, uncertainty rose, and these moves tightened financial conditions around the world.
In Europe and many emerging markets, higher yields and wider credit “scales” are increasing debt service burdens and complicating refinancing for governments and firms. In sub-Saharan Africa and some low-income economies in the Middle East and South Asia, already scarce reserves and limited market access make external shocks to financing conditions more dangerous – especially as higher import bills for fuel, fertilizer and food increase trade deficits and put pressure on currencies. In the Middle East and beyond, high debt levels and tighter financial conditions may further increase debt financing costs.
By contrast, developed economies with deep domestic capital markets and some commodity exporters with abundant reserves, such as Saudi Arabia and the United Arab Emirates – or Latin American commodity producers such as Brazil and Ecuador – may be better able to absorb market stress, even if they are not immune to higher risk premiums.
The author is an economist and scientific advisor
Dejan Jovovic
