Economic consequences of the expanding Gaza war

The escalation and expansion of Israel's war in Gaza and the rerouting of ships along the southern coast of Africa will increase shipping costs by over one hundred percent. International price hikes cause severe hardships for the Sri Lankan economy.

Fuel, food, fertiliser, and raw material imports are likely to increase. International supply chains would be disrupted, and the availability and costs of commodities would be adversely affected. Our import costs may skyrocket.

In brief, if this war persists, Sri Lanka could face another economic crisis.

Escalation

The more than three-month Gaza war is escalating and engulfing other countries in the region. It has become a regional war and is disrupting international shipping and trade.

No peace

At the time of writing this column, there were no signs of appeasement in the conflict. On the contrary, there were signs of many regional countries being drawn into it.

Shipping

An immediate impact of the escalation of the war has been the disruption of shipping, as shipping through the Red Sea has become hazardous. Attacks by Yemen's Houthi forces on ships using the Red Sea passage have necessitated the re-routing of ships using the Red Sea through the southern tip of Africa. This would increase the costs of fuel, fertiliser and food imports and disrupt international supply chains. International trade could be severely disrupted.

Shipping costs

Re-routing of ships to Asia by the southern coast of Africa has increased shipping costs by over 100 percent immediately. Fuel, food and fertiliser supply chains are disrupted. Consequently, international commodity prices will skyrocket. The supply availability and costs of the country’s imports would be affected.

Import prices

Import price increases would be far more than the increases in costs owing to the Value Added Tax (VAT) that people are opposing and increases in import duties that are a percentage of import prices.

Oil prices

Oil prices, which were around US$ 80 a barrel, have not risen immediately owing to increased oil production. Increased production of oil in the US and Canada had stabilised prices.

However, oil prices would likely increase to around US$ 90 a barrel because of the higher costs of shipping rather than reduced supply. Nevertheless, a sharp increase in petroleum prices is expected in the coming weeks.

Other prices

Prices of many other essential imports would also increase owing to the fuel price increase, notably fertiliser, wheat, and building materials.

Consequences

The economic consequences of the war on the

Sri Lankan economy could be severe. The expansion of the conflict and its prolongation will have severe impacts on the global economy and cause unbearable hardships to Sri Lanka’s fragile economy.

Impact on economy

The impact on the Sri Lankan economy, especially the external finances, could be devastating. Import costs would rise sharply, and exports could decrease to widen the trade deficit. The costs of essential imports could skyrocket above affordable prices. The country may be on the verge of another severe economic crisis.

Escalation

The increase in import prices would have a cascading impact on living costs and the costs of production of a wide variety of goods and services. It would increase transport costs, cooking expenditures, and, in turn, the general price level. The cost of locally produced food would increase. This would, in turn, propel a vicious cycle of spiralling inflation.

Fuel and fertiliser

The increase in fuel, fertiliser, and transport costs would increase the production costs of food, thereby adding to inflationary pressures. In turn, manufacturing costs and the price of a wide variety of commodities will rise beyond the buying capacity of most people. This would also result in unemployment and poverty.

Trade balance

The impact on the country’s trade balance could be unsustainable. Import expenditure would rise sharply, especially owing to the huge increase in petroleum and gas prices. Undoubtedly, there would be a shrinking demand for petroleum and diesel owing to the high prices, but even with lower imports, import expenditure is likely to increase.

Exports

On the other hand, exports that decreased last year due to the global recession are likely to shrink further.

Two strengths

The two strengths of the balance of payments last year were inward remittances and earnings from tourism. These two brought in nearly US$ 8 billion and wiped away the widened trade deficit of about US$ 4.7 billion. Consequently, the external reserves increased to about US$ 5 billion (US$ 4.96 billion).

Future

Given the current global conditions, the pertinent question is whether these sources of external finances would be affected by the current insecurity in West Asia.

Remittances

Over one-half of inward remittances are from migrant workers in the West Asian region. If the conflict escalates, the region will become more insecure for foreign employment.

Workers returning

Workers from Israel and Lebanon are returning. Such fleeing for security could affect inward remittances adversely.

The other half of remittances from such countries as South Korea, Japan, and Western countries are not likely to be affected. Yet a decrease of around US$ 2.5 billion would be a severe strain on the balance of payments at a time when the trade deficit is expected to widen and the debt repayment obligations are estimated at US$ 6 billion.

Tourism

The other source of strength for external finances is tourism, which could be affected by threats to air safety and higher costs of air travel. Earnings from tourism of nearly US$ 3 billion last year signalled a revival of tourism that had setbacks from Covid and inhospitable conditions.

Dangers to air traffic through the war zone and increased air fares owing to higher fuel prices could be a severe setback to tourism.

Favourable

On the other hand, people fleeing from Russia and Ukraine and rich Arabs seeking security could boost tourism. Furthermore, a substantial number of tourists are from India and East Asia. They could steady tourist incomes next year.

Summary

The expanding war in West Asia could adversely impact the country’s external finances and heap unbearable financial burdens on the economy and the people. High import costs of essentials are likely to strangle the country’s balance of payments and erode reserves to an unsustainable level. A sharp increase in import prices and a further drop in exports would widen the trade deficit, which would strain the balance of payments. Hopefully, remittances from abroad will continue to be at about last year’s US$ 5 billion, and tourist earnings will continue the upsurge and be around US$ 4 billion or more.

The reality, however, is that these two sources could also be affected by the insecurity of the war in the region.

Conclusion

Unless Israel's war on Gaza peters off and the insecurity of the region is restored, the impact of it on the Sri Lankan economy could be horrendous. We can only hope for an early restoration of peace and a durable solution to the conflict.