On October 7, Hamas attacked Israel by launching around 5000 deadliest rockets from the Gaza strip. Though Israel was caught unaware, yet it retaliated fast and its Prime Minister Netanyahu declared it to be a war, instead of an operation. Incidentally, in 1973 too, it was on October 6 when a coalition of Arab countries launched an attack on Israel on Jews holy day of Yom Kippur. Precisely, in 1973, Saudi Arabia spearheaded OPEC (supported by the Soviet Union) and imposed oil embargo on the nations (the U.S., the U.K., Japan, Canada and the Netherlands) that supported Israel during the Yom Kippur war resulting in a hike in oil prices by 70%. This resulted in a massive energy crisis in the US and inflation reached 12.34%. Energy conservation measures were invoked that included creation of Strategic Petroleum Reserve, speed limit at 55 mph and daylight savings, etc. Shock of the oil embargo was not restricted to one country, region or continent, rather it gripped many developed and developing countries simultaneously. Worldwide escalation in the prices of energy and fertilizer costs triggered food inflation and pushed many into abject poverty. Taking lessons from it, the US initiated the ‘Project Independence’ to free the US from energy dependence. Today, the US is an exporter of oil and thus geo-political dynamics stand completely different from what it used to be in 1973. Hence, even the Arabian countries are restraining from making any knee jerk comment in favor of Israel or Hamas. But one country that is in the centre of the Israel Hamas conflict is Iran. Although Iran has so far denied any involvement in Hamas attack on Israel, yet, it is widely believed that Iran is the leading provider of military aid and training to Hamas. The conflict can escalate in case Iran directly comes in support of Hamas/Palestine in Gaza. It can have widespread economic effects worldwide as the world would be witnessing the second war in the energy zone after the Russia-Ukraine war. The Bloomberg economists have examined the likely impact on global growth and inflation under three scenarios.
In case of scenario I i.e. confined war, the impact on the global economy would remain minimal, particularly if Saudi Arabia and the UAE offset lost Iranian barrels using their spare capacity. In the context of scenario II i.e. proxy war, the conflict may spread into Lebanon and Syria. With Iran supporting armed groups, it would effectively turn into a proxy war between Iran and Israel — and the economic cost would rise. In this case, higher oil prices would also add about 0.2 percentage points to global inflation — holding it near 6%, and sustaining pressure on central bankers to keep monetary policy tight even as growth disappoints. Also, it would add up to a 0.3 percentage-point drag on global growth next year — about $300 billion of lost output — that would slow the pace to 2.4%. Direct conflict between Iran and Israel although is a low probability scenario, but it’s a dangerous one. It could be the trigger for a global recession. Soaring oil prices and plunging risk assets would deal a substantial blow to growth, and take inflation a notch higher.
From the above discussion, it becomes clear that the impact of the Israel-Hamas conflict can be catastrophic if it translates into a direct war between Israel and Iran. It can disrupt the world economies and elicit recession if the economies opt to side with either Israel or Hamas (Palestine). Already Saudi Arabia and Russia which are the major oil producers have announced oil supply cuts to an extent of 1.3 million barrels per day (mbpd) till the end of this year. With Israel Hamas conflict escalation, oil prices may go above the $90 per barrel-mark, thereby reviving inflation, forcing the central banks to keep interest rates high and GDP growth compromised. Countries like India which are amongst the highest importers of crude may further face the global headwinds more than other countries of the world.
Economic Fallout on India
To be precise, the economic impact of this conflict on India can be summarised under three heads i.e. weakness in Indian Rupee, spike in inflation and upsurge in unethical practices. The details of each of these are discussed systematically in the following paragraphs.
Weakness in Indian Rupee: Majority (85%) of India’s oil requirements are fulfilled through imports. An unbridled increase in the price of crude oil can create havoc in the Indian economy. It can adversely affect the import bill thereby pressurizing the current account balance. By and large, when crude oil (Brent crude) increases by $10 per barrel (pbl), the current account deficit increases by 0.5% in India. Such a situation not only casts its reflection on fiscal deficit, rather leads to the depreciation of the Indian Rupee.
Another condition in which the Indian Rupee can depreciate is when inflation (ignited by an increase in the energy prices), worldwide the central banks will increase the rate of interest. Situation may get particularly precarious when the US Fed will again start increasing the interest rate, thereby imparting strength to the dollar index (anything above 100 mark imparts strength to US dollar), which implies a gain in dollar strength vis-à-vis other currencies of the world. In other words, it also connotes the decline of Indian Rupee. Once the Rupee starts witnessing a slide, the additional outflow of foreign portfolio investment from the stock markets will become irrepressible, thereby leaving the stock markets volatile and preventing foreign investors from investing in such markets. It will further put in distress the foreign exchange reserves which will already be under pressure because of an increased import bill payment. In this way, the Indian Rupee may suffer from multiple blows. Summarily, higher crude oil prices will lead to more outflow of dollars from India’s foreign exchange reserves and simultaneously, withdrawal of foreign portfolio investment and its channelization in the US market where interest rates will be high will leave Indian Rupee weak.
Spike in Inflation: Increase in the price of crude oil is not only a headache for the governments, rather businessmen and common public too face its fury. Specifically, an increase in the price of crude oil leads to an increase in the energy costs for the businesses thereby leading to an increase in cost of production ultimately spiking the inflation. Increase in inflation drives down the aggregate demand of the households, particularly when companies transfer the burden of increase in costs on to the consumers. Dejected consumers are thus left with the lesser disposable income to be spent on the non-energy goods. Incidentally, the Indian consumers are already plagued by high retail inflation, particularly in the food products category. The onslaught of high inflation is visible in rural areas more than its counterpart urban areas. This has eventually led to the creation of a ‘K’-Shaped economy, where the rich are getting richer and the poor are getting poorer.
Prices of essential food items like wheat, rice, sugar, spices, and milk, etc. are well above Reserve Bank of India’s tolerance limit and consecutive two years of early onset of summers and bad rains have almost dashed the hopes of any respite in near future. The government of India has accordingly repeatedly interfered in the food market to control the situation. The government has continued the ban imposed on export of wheat (last year) in this year too, besides banning the export of non-basmati and basmati rice besides sugar. Further, the stock limits are imposed on pulses like tur and urad. 40% export duty was imposed on onions to curb their export so as to stabilize the domestic prices. Despite all attempts, consumers are continuously reeling under the high prices of essential commodities and an increase in the prices of crude will rub salt to their wounds.
Upsurge in Unethical Practices: Beside above fallouts, there is a lurking fear of an increase in the adoption of unethical practices in international trade. Recently, it has been witnessed that during the Russia Ukraine war, when sanctions got imposed on Russian crude export, alternative illegitimate measures were adopted to export the Russian crude oil (Ural) and to earn foreign exchange. It is popularly known as Russia’s “ghost”, “shadow”, or “dark” fleet. A fleet of nearly 500 ships, majority old tankers with sham ownership and vague insurers were pressed into service to export crude to China and other Asian economies. The ships succeeded in hiding their location particularly when they lifted oil from Russian ports and the same after getting unloaded in India and other economies was re-exported to European economies. It is estimated that nearly 12% of the world’s shipping market is now “dark” which is circumventing the regulatory conditions imposed. Such practices may pick up further in case the Israel-Palestine conflict translates into a war. These practices not only lend a bad name to an economy, rather opaque procedures further lead to an increase in inequality in an economy, where few multimillionaire continue to earn unscrupulous money and public is bereft of any gains.
Alongwith the above economic fallouts, there is a likelihood of an impact on the bilateral trade between India and Israel too. The bilateral trade between two countries is carried out in pharmaceuticals, agriculture, water, IT and telecom sectors. India exports precious stones and metals, chemical products and textiles to Israel, whereas we import pearls and precious stones, chemical and mineral/fertilizer products, machinery and electrical equipment, petroleum oils, defense machinery and transport from Israel. An escalation in this conflict would not only disrupt the trade between India and Israel, rather it will affect industries and render many unemployed.