The Middle East War Shock!

 

A resilient world economy is being tested again by the war in the Middle East. The conflict has caused considerable hardship around the globe. This requires understanding the nature of the shock, the channels through which it affects the economy, the size of the impact, and the policies that can mitigate it. (This is an extract of a speech by the IMF Managing Director in Washington DC).

 

So what hit us? A supply shock that is large, global, and asymmetric:

 

·             It is large because the world’s daily oil flow cut by some 13 percent, and its LNG flow by some 20 percent;

·             It is global because all of us are now paying more for energy and with supply chains disrupted across the world;

·             And it is asymmetric because its impact depends on proximity to the conflict.

 

As always, a negative supply shock pushes prices up. As a point of reference, Brent jumped from $72 per barrel on the eve of hostilities to a peak of $120.

 

The supply interruptions have had—and will for some time continue to have—ripple effects, such as:

 

·             Oil refinery disruptions given the need to maintain minimum flow rates, with warning lights flashing red in many far-flung places;

 

·             Shortages of refined products including diesel and jet fuel, which have disrupted transportation, trade, and tourism in a world more interconnected than ever;

 

·         Food insecurity for another 45 million people given the transport issues—taking the total number of people in hunger to over 360 million—with the problem potentially worsening over time because of higher fertilizer prices;

·         And supply chain disruptions given industrial dependencies such as on sulfur, helium for silicon chipmaking and MRI imaging, and naphtha for plastics.

 

The second question is: how can this shock play out? Through three main channels:

 

·         First: the price impact and supply shortages. Higher prices for key inputs feed into many consumer goods, lifting inflation. This, coupled with shortages, reduces demand by brute force.

·         Second channel: inflation expectations. These can break anchor and ignite a costly inflation process.

·        Third channel: financial conditions.

 

We have been here before in the 1970s and earlier this decade.

How large is the growth impact? What we do know is that growth will be slower—even if the new peace is durable. And we also know there are significant variations across the world. Countries able to export oil and gas undisturbed are the least affected. In contrast, countries directly disrupted by the war—including oil and gas exporters who suffered the blockade—and countries relying on imported oil and gas, still bear the brunt of the impact.

 

How bad this impact will be will depend, in no small measure, on how much policy space countries have, including oil and gas reserves, given the five-week gap we have seen in tanker traffic from the Gulf.

 

The answer very much depends on whether the ceasefire holds and leads to lasting peace and how much damage the war leaves in its wake.

 

For Malaysia, the impact maybe subdued because we are net exporter of oil and gas. But inflation will remain elevated because non-subsidised fuel like diesel will increase transport costs which will then be passed onto consumers. Food imports may cost higher but contained if ringgit holds against the dollar. Supply chain disruptions may occur for those that need oil (from the Middle East) for their output of plastics, silicon chip making or MRI imaging.

 

The Government has a task force to monitor the impact and propose measures but it will be good if they do a weekly communication on pump price changes, subsidies provided (or increased) and how inflationary pressures are being addressed.

 

Reference:

Cushioning the Middle East War Shock (speech by IMF Managing Director Kristalina Georgieva at the 2025 Spring Meetings in Washington, DC).