Economic turmoil is coming to the Middle East

The conflict in the Middle East continues to escalate. On January 11th, the United States and Britain began attacking Houthi strongholds in Yemen in response to months of Houthi missile strikes on ships in the Red Sea. Five days later, Israel launched its most extensive targeted barrage into Lebanon, targeting Hezbollah, a militant group backed by Iran.

Although a full-blown regional war has been avoided so far due to a mutual lack of interest from Iran and the United States, the economic repercussions of the conflict are already significant. Trade routes have been disrupted, causing a negative impact on global shipping and local economies in the Middle East. The region’s most productive industries are facing severe challenges, and in Lebanon and the West Bank, increasing hardship raises the risk of further violence.

Starting with trade, prior to Hamas’s attack, a fifth of the average Middle Eastern country’s total exports, including Israeli tech and Gulf oil, were sent within the region. However, with the blockade of key routes, over half of all goods transportation has been halted, leading to a collapse in intra-regional trade. Additionally, the increased cost of shipping goods out of the Middle East is expected to force many exporters, operating on thin margins, out of business in the coming months.

The Red Sea, which previously handled 10% of global goods transportation, has seen its shipping volumes drop to just 30% of normal levels since the Houthi missile launches. On January 16th, Shell, an oil and gas giant, announced its decision to avoid the Red Sea.

For countries bordering the Red Sea, Houthi missile strikes have severe consequences. Eritrea, dependent on fishing, farming, and mining exports, faces challenges due to its reliance on sea transport amid strained relations with its neighbours. Sudan, already in crisis, relies on the Red Sea as the sole point of entry for aid, which has largely been impeded since the attacks began, leaving 24.8 million people in need without adequate assistance.

Further disruption could bring financial ruin to Egypt, one of the region’s largest countries. The Red Sea is crucial for Egypt’s population of 110 million as it serves as a vital source of dollars. The government earned $9 billion in the year to June from tolls on the Suez Canal, linking the Mediterranean to the Red Sea. Without this toll revenue, Egypt’s central bank would have depleted its foreign exchange reserves, which were $16 billion (equivalent to two months’ worth of imports) at the beginning of 2023. The government would also have faced a significant budget deficit, already relying on cash injections from Gulf states and the IMF.

Potential crises may materialize in 2024. Egypt’s income from the Suez Canal for the year to date is 40% less than it was at the same time last year, putting it at a real risk of running out of dollars, leading to a government default and budget turmoil.

The conflict has also impacted the Middle East’s most promising industries. Israel’s tech sector, previously contributing a fifth of the country’s GDP, is now struggling. Investors are withdrawing funding, customers are cancelling orders, and much of its workforce has been called up to participate in the conflict.

Jordan is suffering from a loss of tourism, constituting 15% of its GDP, and this struggle is representative of challenges across the region, including a decline in tourist numbers even for Gulf states. In the weeks after Hamas’s attacks, international arrivals to Jordan fell by 54%, leaving it close to default due to lost revenues.

The most dangerous economic consequence of the war may be the hardship inflicted on populations in Lebanon and the West Bank, potentially leading to more violence. As Israel and Hezbollah engage in air strikes, southern Lebanon is being destroyed, with over 50,000 people already displaced (along with 96,000 in northern Israel). Repair costs are high, but Lebanon lacks the funds, having had a shell government since it defaulted in 2019. In recent months, its economic decline has accelerated as foreign tourists and banks, constituting 70% of its GDP, have deserted the country on the advice of their governments.Top of Form

The situation in the West Bank is grim. Out of its 3.1 million residents, 200,000 factory workers who used to commute to Israel daily are now unemployed after Israel revoked their permits. Additionally, 160,000 civil servants have not received their salaries since the war began. The West Bank’s government refuses to accept tax revenues from Israel, which collects them, due to Israel withholding funds earmarked for Gaza. Public services are shutting down, and missed mortgage payments from civil servants pose a risk of triggering a banking crisis.

The Middle East, historically teetering on economic instability, faces heightened risks due to Israel’s conflict with Hamas. Governments in the region have relied on precarious financial structures, balancing bailouts from Gulf states, aid from the United States, and costly short-term loans. The potential for a collapse is alarmingly high.

While the global economy has, so far, experienced minimal costs from the conflict with relatively stable oil prices, a broader debt crisis in the Middle East could rapidly change that. The impact would be felt by young, urban populations facing increasing unemployment, potentially leading to more extreme political dynamics in strategically important yet chronically volatile countries. The repercussions would extend across the world.