It is important to understand the Middle Eastern geopolitical landscape in brief to delve into its impact on the global and Indian economy.
While the Islamic world supports the cause of Palestine it has its own internal dynamics which is fairly complex. Saudi (primarily Sunni) and Iran (Shia) are archrivals and have long been battling for supremacy in the Middle East. While Jordan and Egypt have signed peace treaties with Israel, Lebanon, backed by Iran, continues to pose a threat to Israel through its militant organisation Hezbollah on its northern side. Saudi Arabia has currently taken a carefully crafted stance of “restoring peace” in the region while obviously showing solidarity towards the Palestinians. However, it also has warm relations with the US, and has been trying to normalise ties with Israel through a peace deal which has been brokered by the US in its efforts to counter China’s presence in the region. It should be noted that Israel was attacked just a few days after the basic framework of the Israel Saudi agreement was announced by the US. The deal would have been a win-win for Saudi, US and Israel but had obviously irked Iran which backs Hamas. The deal currently looks “off the table” at least in the near term. Such a deal could potentially change the Middle East geopolitical dynamics putting Saudi in the forefront in the region.
Economically, the Middle Eastern (ME) region is significant. While Israel alone accounts for a mere 0.4% of global GDP, 0.3% in global exports and is also not a major oil producer, the ME region together accounts for 30% of global oil production and 5% of global GDP. Saudi is the largest oil producer in the region accounting for 13% of global oil production. Iran on the other hand accounts for 4% share. Iran plays a critical role here not only because of the quantum of oil production but more importantly because of supply of oil through Strait of Hormuz, which is a critical shipping artery which Tehran controls. This strategic waterway is the most important passage for oil trade from the Gulf region to the rest of the world. Over 85% of Gulf oil and 20 to 30% of the world’s total oil consumption flows from here. Any disruption to this route by Tehran can have a huge impact on supply and prices of oil. Moreover, any escalation in US- Iran tensions and tightening of US’ sanctions on Iran which it had relaxed in the past will also impact the flow of oil.
Thus, the near-term economic impact of the war on the global economy would emanate from its impact on global oil prices and its ripple effects on inflation and growth. Having said that, rising geopolitical fragmentation has been a key deterrent for the global economy’s already fragile economic recovery. The IMF, in its latest edition(October) of World Economic Outlook, forecasts global economic growth to slow down to 3.0% and 2.9% in 2023 and 2024 respectively from a 3.5% year on year growth in 2022. This of course does not consider the current war situation. If the war is limited to Israel and Gaza the impact on oil prices will be limited, however, a major risk may arise if the war spreads to the rest of the region. Thus, the extent and duration of war and role of key players like Iran and Saudi would determine the trajectory of global growth going forward. That’s why all eyes are currently on this region.
Apart from the impact through higher oil prices any geopolitical crisis results in capital flowing towards the safe haven assets like U.S. Treasury bonds, gold and currencies like USD, JPY and Swiss Franc. This risk-off scenario will also result in depreciation of emerging market currencies in the near term. But more importantly the biggest downside of the war is the uncertainty it brings along about future growth trajectory which forces the Central Banks world over to “wait and watch” and keep interest rates higher for longer which hampers aggregate demand and growth prospects in the medium term. Central Banks thus would keep their rate easing cycle on hold citing caution with respect to the geopolitical situation.
Against the global economic backdrop, India shines bright. A resilient Indian economy is projected to grow by 6.3% yoy in FY24 (IMF), one of the fastest growing major economies in the world. India’s economic performance has been fairly resilient despite the pandemic and the Russia Ukraine crisis primarily due to a strong domestic economy and sound macroeconomic policies. However, India is not completely decoupled from global economic vagaries, with its GDP growth projected to slow down by almost a percentage point in FY24 compared to FY23 and the rupee and exports continue to be under pressure.
In terms of its relations with the region, India has carefully walked the tightrope, managing its diplomatic relations with the Arab world. It has warmed its ties with Saudi and UAE while maintaining a fine balance with Iran. India’s diplomatic relations with Israel are especially strengthened under Prime Minister Modi. As far as India’s merchandise trade with Israel is concerned, bilateral trade between the two countries stood at about $10 billion in FY23 with $3 billion of imports from Israel and $7 bn of exports to Israel. India mostly imports pearls, precious and semi-precious stones and metals (35% of total imports), electric machinery (18%), fertilisers (17%), mineral fuels and oils (8%) and machinery from Israel. Almost 80% of India’s exports to Israel comprise mineral oils and fuels and precious stones, diamonds, and metals. Most of the trade happens mostly through the Eilat port, located on the Red Sea. So far there is no report of port disruption. While the direct conflict between Hamas and Israel may not impact India, involvement of multiple actors in the war can destabilise the security and stability of the West Asian region impacting India’s energy supply. Currently India imports 60% of its oil requirement from the Middle East. The uncertainty about trade routes and supply chain disruption continues to pose a risk for the global and Indian economy alike.
For India, however, one of the biggest downsides is the uncertainty that lies ahead with respect to the India Middle East Europe Economic Corridor (IMEEC). Seen as a counter to China’s Belt and Road Initiative, IMEEC was announced on the sidelines of the G20 summit in Delhi. The corridor has the potential to enhance trade connectivity, create clean energy pathways, digital infrastructure and sustainable economic growth in the region. It comprises two multi-modal separate corridors – Eastern corridor connecting India to the Arabian Gulf and – Northern corridor linking the Gulf to Europe through sea and rail route. It is expected to reduce shipping times by as much as 40% and reduce logistics cost significantly. The Middle East and EU are amongst India’s largest trading partners and trade has grown over the years. Both geo politically and economically India stands to gain from IMEEC. However, the war could delay talks with respect to the economic corridor.
While the economic consequences of the war will be known as the conflict unfolds over the next few days or months, the humanitarian consequences of any war are irreversible. In the words of Bertrand Russell “War doesn’t determine who’s right- only who is left”.
Prachi Priya is a corporate economist based out of Mumbai. She has previously worked at J.P. Morgan for 3 years in Singapore ...
