BROOKINGS COMMENTARY The Israel and Gaza war: Economic repercussions Gian Maria Milesi-Ferretti October 23, 2023

 BROOKINGS

COMMENTARY

The Israel and Gaza war: Economic repercussions

Gian Maria Milesi-Ferretti

October 23, 2023

The tragic loss of life and the risks to peace in Israel, Gaza, and the rest of the region

clearly are foremost on people’s minds. We provide here a brief discussion of the

possible economic repercussions, bearing in mind the extreme uncertainty

characterizing the situation. The repercussions of the crisis are dependent on the

extent and duration of the fighting, associated geopolitical tensions, and the possible

occurrence of terrorist attacks. While the overall reaction of financial markets has been

relatively muted so far, the risks of an intensification and broadening of the conflict are

material, and their potential fallout could be severe, especially for countries in the

region.

Energy markets

From a global economic perspective, energy is the most important short-run issue. Oil

prices were already elevated at the time of the attack on Israel, and these

developments raise the probability of supply disruptions (particularly if the crisis

involves Iran or if unrest takes a toll on production in Iraq) and market nervousness

more generally. Oil prices have risen by about $5 a barrel since the start of the

conflict, even though oil production does not seem to have been affected. Oil supply

shocks would take a toll on economic activity in energy-importing countries and on

the global economy more generally, with IMF estimates suggesting that a 10%

increase in oil prices could weigh down global growth by 0.15 percentage point. A

number of oil importers in the emerging and developing world, such as Pakistan,

already face a challenging economic outlook. Disruptions to gas supplies are also

possible (there were some production stoppages in Israel’s Tamar field), and we have

seen upward pressure on European gas prices. Increased tensions in the Middle East

could also reverberate to the supply of European gas from countries in the region.

In addition to the negative impact of energy price shocks on economic activity, rising

energy prices would further complicate the task of central banks around the world

trying to bring inflation back to target. IMF estimates suggest that a 10% increase in

global oil prices could increase inflation globally by 0.4 percentage point.

Global risk aversion

Rising geopolitical tensions generally take a toll on global risk sentiment, widening

spreads and putting further upward pressure on the dollar. The ensuing tightening in

global financial conditions can have severe repercussions for economies with external

vulnerabilities. Among those, there are several emerging markets and developing

economies that were already facing external debt problems and loss of confidence by

international investors. In addition to the impact through financial markets, rising

tensions and the possibility of acts of terrorism beyond the region have the potential

to take a toll on confidence more generally, and hence on aggregate demand.

Over the past two weeks, financial market reactions have been muted, with a very

modest decline in global stock prices and a small widening of spreads. U.S. long-term

interest rates, which normally decline on rising risk-off sentiment, have actually risen,

possibly reflecting concerns that higher energy prices will raise inflationary pressures,

thus leading to tighter monetary policy. But the risk remains that an intensification and

widening of the conflict would trigger a more pessimistic financial market reaction.

Regional outlook

The Israeli economy starts in a strong position and has shown remarkable resilience to

periods of strife and outright war in the past. The economy has grown at a fast rate

since the global financial crisis of 2008-09 (4.2% on average, and 2.2% in per capita

terms), and its GDP exceeded $500 billion in 2022 ($54,000 in per capita terms). The

country has a net external creditor position exceeding 30% of GDP, and foreign

exchange reserves exceeding $200 billion. This notwithstanding, the country is clearly

affected through multiple channels, including the impact of military mobilization on

labor supply, reduced tourism, and the impact of increased security concerns on

public spending needs, investment, and capital flows. The shekel, which had

weakened in the months prior to the attacks on concerns related to the Supreme

Court controversy, has depreciated by about 5% in nominal effective terms since early

October, and the Bank of Israel has taken measures to stabilize financial markets,

including through the of a program to sell up to 30 billion USD in foreign exchange reserves.

Other countries in the region start in a weaker situation. Lebanon is still mired in a

financial crisis of extreme severity, with a GDP decline exceeding 50% since 2018.

Jordan has high external debt (its net external liabilities exceed 110% of GDP) and

persistent regional strife could take a severe toll on domestic stability and tourism,

which is an important source of foreign exchange. Egypt is similarly dependent on

tourism flows for hard currency receipts, and is facing a difficult macroeconomic

outlook, with wide spreads on its external debt and pressures on its heavily managed

exchange rate. The economic situation in Gaza, which was very difficult to start with,

is dramatic, with large short-run needs of emergency aid and daunting prospects for

reconstruction and future economic activity more generally. And of course, the fading

of prospects for a more durable normalization of relations with Israel and lower

announcement regional tensions is bad news for a broader set of countries in the Middle 

East and beyond.

AUTHORS

Gian Maria Milesi-Ferretti Senior Fellow