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Will the economic impact of the escalating Middle East conflict multiply?

Analysts say the wealthy Gulf oil exporters are more insulated from the shocks than their fragile neighbors.

Will the economic impact of the escalating Middle East conflict multiply?
[Source photo: Krishna Prasad/Fast Company Middle East]

In January, on the sidelines of the World Economic Forum in Davos, Qatar’s Finance Minister Ali Al Kuwari said the war in Gaza will hit economies across the Middle East if it is not resolved.

“The solution is really to look for a permanent solution for the main issue in the Middle East, which is the Palestinian problem… This cannot be fixed by military actions,” Al Kuwari told Reuters. “If you leave them long term unresolved, we will always go through cycles of violence, cycles of unrest, and which always will slow down the region.”

Almost a year on, how is the ongoing war weighing on the growth of the economies across the region? Is it exacerbating the existing drag on economic activity? 

While a full-blown regional war has been avoided so far, the recent events have deepened the fear that the conflict might begin to pose a long-term threat to the region’s economy.

“The escalating Middle East conflict has the potential to increase inflation and deter FDI, particularly if the situation intensifies and involves major players like Iran,” says Shivansh Rachit, Founder and Group President and Executive Chairman of Hedge & Sachs.

The consequences of conflicts in the region are already vast.

The International Monetary Fund’s latest Regional Economic Outlook for the Middle East and Central Asia stated that a year after the start of a severe conflict, countries in these regions lost about 2% in real GDP per capita compared to before the conflict, with the decline extending to about 10% after a decade.

The findings underscore the adverse effects on economic performance, including higher inflation and lower consumption, investment, exports, and fiscal revenues.

KNOCK-ON EFFECTS

Analysts say the Israel-Hamas war spilling into the wider region will hit investor confidence and affect sectors from tourism, retail, and real estate to oil, precious metals, and even new energy. However, the wealthy Gulf oil exporters are more insulated from the shocks than their more fragile neighbors.

“Countries like Egypt, Jordan, and Lebanon are feeling knock-on effects, which are already suffering economically from political deadlock, currency collapse, and social unrest,” says Marc Pussard, Head of Risk at APM Capital. 

The recent estimate by the UNDP states that post-war reconstruction in Gaza will cost around $50 billion and might take as long as 80 years before Gaza is fully rebuilt. The economy of Gaza and the West Bank was $19 billion in 2023. 

“Gaza’s economy is wiped out; it’s more than 80% gone. The West Bank is also severely impacted,” Kristalina Georgieva, head of the IMF, said during a speech in Washington recently.

In May, Bank of Israel Governor Amir Yaron warned that the ongoing war with Hamas will incur $67 billion in defense and civilian costs between 2023 and 2025. In August, the Finance Ministry said Israel posted a budget deficit of $3.24 billion, citing high expenses to finance the war.

In Lebanon, the war has already cost more than $10 billion, according to the Minister of Economy and Trade.

Tourism plays an important role in the economies of Lebanon, Egypt, and Jordan. After finally recovering from the aftereffects of the COVID-19 pandemic, hoteliers had been expecting an almost full occupancy rate, but visitor bookings are falling in these countries because of fears around the nearby conflict in Gaza.

Tourism accounts for about 12% to 26% of the current account receipts for Lebanon, Jordan, and Egypt, and according to S&P estimates, the sector could lose over $16 billion in tourism revenue due to the war.

“In 2023, Egypt generated around $13.63 billion in revenues from tourism. Given the conflict, tourism revenue alone is expected to be 10-30%, which could cost the country 4-11% of its foreign exchange reserves,” says Arun Leslie John, chief market analyst at Century Financial.

Meanwhile, attacks by Houthi rebels on ships in the Red Sea have disrupted maritime trade routes. Traffic through the Suez Canal—a significant source of revenue for Egypt—has plummeted. The war has reduced traffic through the Suez Canal by 70%, resulting in around $3.5 billion in lost revenue. The IMF expects Egypt’s 2024 real GDP growth to drop 3% from 3.8% in 2023.

UNAFFECTED BY THE WAR

“Yet other countries in the region who perhaps enjoy a more stable eco-political environment have emerged unscathed. Price shocks to oil and regional country-wide stock indices were quickly pared, showing little contagion to the conflict,” adds Pussard.

According to John, the economic impacts aren’t severe in countries like Saudi Arabia, Qatar, and the UAE. “This is evident from the real GDP growth projections, and this can mainly be attributed to the diversification policies taken by these economies and their geographical distance from the tension zone.”

However, voluntary oil cuts and lower oil prices have slowed their economic growth in real terms this year.

Saudi Arabia, which posted a budget deficit of $3.30 billion in the first quarter of 2024 after lower oil revenues, is projecting budget deficits through 2026.

GDP growth was nearly flat last year after several oil production cuts.

IMPACT ON FOREIGN INVESTMENTS, INFLATION

The heightened geopolitical risk is clouding investment decisions in the wider region, but countries like the UAE and Saudi Arabia continue to attract foreign investment. In 2023, the UAE attracted $30.6 billion compared to $22.7 billion in 2022, a 35% YoY growth. 

“This outperformance is expected to continue mainly due to an influx of foreign companies and an increase in real estate activity,” says John.

“The GCC countries not directly involved in the conflict have largely seen FDI levels continue their previous trajectory,” adds Pussard. “Whereas, unsurprisingly, Israel saw FDI drop from $23 billion to $16 billion.”

Rachit says the recent sensitivity of energy prices to events in the region suggests that inflationary pressures could persist, especially during the winter. “Investors might become wary, leading to reduced FDI inflows, as uncertainties over future demand and financial conditions make the region less attractive for investment.”

Sustaining large-scale economic plans isn’t easy in an unsafe, volatile, and conflict-prone geography. There are concerns that instability could delay or halt ongoing and planned projects. 

Saudi Arabia and the UAE have been directing hundreds of billions of dollars toward building infrastructure to attract foreign investments and building alternative industries in areas such as manufacturing, services, tourism, entertainment, and so on.

In May, speaking at the Qatar Economic Forum, Saudi Finance Minister Mohammed al-Jadaan noted that the wars in Ukraine and Gaza and problems like inflation and supply chain disruptions are collective shocks that “call us to reprioritize, to look at what we are doing, and how can we actually optimize what we are doing, optimize our plans.”

This came after the Saudi finance minister said last December that the country had decided to extend the timeframe for some major projects past 2030 without specifying which ones. 

However, Pussard says that developmental projects are proceeding without pause in some countries, including efforts to capitalize on tourism potential.

“For example, Kuwait has announced plans to build the world’s tallest tower, called the Burj Mubarak al-Kabir; Oman’s Vision 2024 includes ambitious projects to capitalize on its already growing tourist numbers, projected to be up by 25% in 2024 to a total of 5.3 million. In the UAE, Etihad Rail has announced plans to create a rail network linking the UAE to Oman, Qatar, and Saudi Arabia, allowing for the first time inter-regional passenger travel for the GCC.”

Saudi Arabia is embarking on new projects with unique, complex designs that defy belief. In addition to the 10,200-square-mile urban development, NEOM, the country will finish 11 new soccer stadiums and expand four more before the World Cup kicks off in 2034, reportedly costing “hundreds of billions of dollars over the next decade.” 

ENERGY MARKET AND GLOBAL IMPACT

However, for now, the worry about the economic consequences remains focused on the energy market. There are concerns that high oil prices and potential supply disruptions will keep inflation high. The region heavily influences global oil and gas production.

“The main concern is the potential disruption of global oil supplies, as the Middle East plays a pivotal role in the global energy market, producing 35% of the world’s oil exports. Any conflict that threatens oil production or transportation routes could lead to spikes in energy prices, which would have profound consequences for regional development projects,” says Rachit. 

“Though renewable energy is gaining traction, crude oil is still the foundation of modern life and in virtually every product; hence, a disruption in its access could result in drastic price fluctuations from current levels globally,” adds John.

The Middle East is also at the crossroads of global trade, with key maritime routes connecting Asia, Europe, and Africa, such as the Suez Canal and the Strait of Hormuz. “Any disruptions to these routes can cause major global trade slowdowns, as recent attacks by Yemen’s Houthi rebels have amply demonstrated,” says Pussard.  

According to the WTO, the UAE is among the top five nations in re-export operations. Re-export allows businesses to reach new markets and expand their customer base by capitalizing on favorable trade conditions, says John. “This disruption could adversely impact global trade.”

The effects of conflicts extend far beyond economic impacts, leading to immense human suffering, loss of life, and heightened vulnerability to food insecurity. Analysts say countries in the Middle East are already implementing measures to promote economic resilience and stability. 

However, policies aimed at buffering against economic shocks, maintaining fiscal stability, and preserving investor confidence are essential for mitigating the conflict’s adverse effects on the regional economy. 

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ABOUT THE AUTHOR

Suparna Dutt D’Cunha is the Editor at Fast Company Middle East. She is interested in ideas and culture and cover stories ranging from films and food to startups and technology. She was a Forbes Asia contributor and previously worked at Gulf News and Times Of India. More

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