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Middle East Trouble: Global Economy and Credit at Risk from Politics

Middle East Crisis: Geopolitics Remains a Downside Risk for the Global Economic and Credit Outlook

Iran’s recent drone and missile attack on Israel, despite being anticipated days in advance, was largely thwarted by the air defenses of Israel and its allies. This attack could be interpreted by Tehran as retribution for Israel’s alleged assassination of Iranian military commanders in Damascus, while also potentially providing an opportunity for de-escalation.

However, there remains the possibility, if not the likelihood, of retaliation from Israel. The focus now lies on the nature of any reprisal and the extent of Israel’s restraint, including its actions in Gaza.

The ramifications of a wider conflict or direct confrontation in the Middle East would extend beyond the region, impacting global commodity markets. Oil markets have already factored in prolonged tension and heightened geopolitical risk, with Brent prices hovering around USD 90 per barrel.

However, further escalation could lead to significant economic repercussions worldwide, including higher commodity prices, disruptions in shipping routes, and risk aversion in financial markets.

Middle East Trouble: Global Economy and Credit at Risk from Politics

Middle East Trouble: Global Economy and Credit at Risk from Politics (Credits: The New York Times)

A broader conflict in the Middle East could disrupt a substantial portion of global oil and natural gas production, with the potential to affect up to a third of oil production and about 15% of natural gas production.

While Iran’s oil production is relatively modest at around 3.5% of global output, its natural gas production holds more significance at approximately 6%. The strategic importance of the Strait of Hormuz for crude oil producers like Saudi Arabia, Iraq, the UAE, and Kuwait, as well as for Qatari gas exports, underscores the global impact of any disruption in the region.

Further escalation in geopolitical tensions could exacerbate inflationary pressures and increase economic uncertainty. Geopolitical risks and supply-side crises pose a significant challenge to achieving price stability goals, particularly amid signs of persistent inflation.

Any escalation in the Middle East conflict may prompt central banks to delay or moderate future interest rate reductions, potentially leading to a scenario reminiscent of the 1970s with higher and more unpredictable interest rates.

Geopolitical tensions not only pose sovereign credit risks to Israel but also have broader implications for global sovereign credit ratings. Increased military expenditure due to geopolitical risks, counter-cyclical fiscal policies to address economic uncertainty, and the prospect of higher interest rates for an extended period are factors contributing to this credit challenge.

While these risks have been factored into sovereign ratings for 2024, geopolitical concerns are likely to persist and influence the credit outlook for 2025 and beyond.

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