But the potential danger that markets may be underestimating is that sharp falls and heightened volatility in currency, commodity, equity, and bond markets could expose latent financial and economic vulnerabilities in the global economy.
A conflict likely to drag on
The objectives of the US and Israel, along with Iran’s survival strategy, make a near-term end to the fighting unlikely. Even if the US seeks de-escalation, Israel’s stance will complicate that. Israel is determined to eliminate any threat from Iran and is willing to pay a high price to do so.
For its part, the Iranian regime does not trust the US, making good-faith negotiations impossible. Its strategy is to impose as high a cost as possible, in terms of soaring oil prices and attacks on US allies in the region, to force the US to back off. As a result, the war could drag on for weeks, if not longer.
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The longer the crisis continues, the longer shipping through the Strait of Hormuz will be disrupted. Since the Strait links the Persian Gulf to the Indian Ocean, this will cripple shipments of critical goods to the global economy, including crude oil, natural gas, refined petroleum, petrochemicals, fertilisers and aluminium. The knock-on effects will be both significant and damaging.
Iran’s navy has been largely scuttled, and a significant portion of its missiles reportedly destroyed. However, the regime still controls shore-based drones and unmanned vehicles that can attack ships passing through the Strait. Disrupting the marine traffic through the Strait of Hormuz is Iran’s most effective tool for imposing economic costs on the US coalition.
Actions by the US and others will take time and may not be enough. Naval convoying is theoretically viable — during the 1980s Iran-Iraq war, the US and allies ran Operation Earnest Will (1987–1988), protecting Kuwaiti tankers from Iranian attacks to keep traffic moving. But such operations require months of preparation, and the US has yet to start.
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The US and Gulf nations are working to secure Ukrainian interceptor drones, proven effective against Iran’s Shahed drones. However, logistical challenges mean the solution is still weeks away. Trump’s promise of shipping insurance may help, but only to a limited extent — shipping firms won’t act until the threat is visibly reduced.
In other words, the war will likely hinder global growth significantly. Estimates vary, but most analysts predict a reduction of at least 0.2 to 0.5 percentage points from the previously expected 2.8% to 3% global growth. Global inflation could rise by 0.8 to 1.2 percentage points, while oil-importing countries may see their trade deficits widen by around 1% of GDP.
New stress points
The scale of damage to global economic conditions is concerning. But the potential dangers go beyond this — there is a risk that the aftereffects of the Iran crisis could ignite pre-existing vulnerabilities.
Take the US economy as an example. It appears to be better-positioned to absorb an oil shock than in previous Middle East crises. The US is unlikely to face a supply-side energy crisis because its shale production can absorb a large share of that impact. But its energy prices will follow global prices and surge, raising inflation and complicating the Federal Reserve’s monetary policy decision-making while also increasing business uncertainty. These factors could trigger existing weak points in the US economy.
- America’s recent growth has been excessively dependent on the AI capital expenditure boom, a boom premised on cheap and abundant energy, since data centres and GPU clusters are energy-intensive. Companies spending billions on AI probably did not factor in such high power and fuel costs as now prevail. Concerns about stretched AI valuations will grow, and a reassessment of project commitments is likely to reverse some of the capital spending.
- Private credit markets present another risk because the lending has been concentrated in logistics operators, manufacturers, and distributors with thin margins and significant exposure to energy costs. A sustained rise in energy costs directly hits operating cash flows, impairing debt serviceability. Covenant-lite documentation means that stress may not surface until a refinancing event forces it into the open, at which point contagion to broader credit markets becomes harder to contain.
- US households, particularly those on lower incomes, were already under strain as pandemic savings had been exhausted and real wage gains had narrowed. This is one reason why credit card delinquencies have been rising recently. A rise in gasoline prices will compress real incomes and spending power. The resulting weaker consumption spending would remove a significant buffer just when other stresses are building.
Slower US consumption and investment would reduce import demand, creating significant challenges for Asian exporters. A weakened American economy would also heighten investor risk aversion, given the crucial role US demand has played in the global economy. As a result, more risk-off episodes can be expected, leading to outflows from emerging markets and tighter financial conditions across the region.
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Asian economies must brace
A prolonged disruption in the Strait shipping would trigger a sharp energy supply shock in Asia. Even countries less reliant on the Persian Gulf would face higher energy prices. The region’s energy supply is dominated by oil, gas and coal, with renewables playing only a minor role.
- Countries that rely heavily on imported oil and gas will be more exposed to supply disruptions and deteriorating terms of trade. Most major Asian economies are net oil importers, with only Malaysia and Indonesia meeting at least 40% of their demand from domestic production. The gas situation is more mixed: Indonesia and Malaysia are net exporters, while Vietnam, once self-sufficient, is set to become a net LNG importer in the coming years due to rapidly depleting fields.
- Despite its vulnerability as a highly open economy, Singapore has several offsetting factors. As a regional refining and trading hub, much of its crude oil is processed for re-export, overstating its domestic exposure. Its power sector is mainly gas-fired, with secured supplies. Additionally, its role as a commodity trading hub offers more supply flexibility than its import ratios suggest.
- Taking energy structure and trade balance factors together, the countries that are most directly exposed to a Hormuz-driven energy price shock are the high-income East Asian economies, the Philippines, and Thailand, owing to their heavy dependence on oil and gas for energy and their limited domestic production.
That said, Asian economies have made progress in reducing the energy intensity of growth. Cross-country differences reflect diverse industrial bases, with lower-income economies generally showing lower energy intensity due to a greater reliance on lower-value-added activities, such as informal services and basic manufacturing, that require less energy. From a long-term perspective, most countries are better positioned to withstand an energy shock than in previous decades, thanks to improvements in energy efficiency driven by both technological advances and government policy.
But the danger goes beyond the damage from high energy prices:
- Indonesia is a major importer of refined petroleum, making its current account highly sensitive to commodity price swings. More critically, the rupiah is one of the region’s most volatile currencies during risk-off periods. With Bank Indonesia’s ability to cut rates already limited by the need to defend the currency, that space is shrinking. Investor confidence in Indonesia’s policy framework has been shaken by concerns from rating agencies over its fiscal policy and market transparency, leaving the rupiah and Indonesian equities vulnerable.
- The economies of Thailand and the Philippines are currently growing below their potential, while policy uncertainty has dampened investor confidence. This could limit their ability to cope with an external shock and adverse changes in trade terms. The Philippines faces another risk, as it depends heavily on remittances, much of which comes from Filipino workers in the Middle East.
Beware the longer-term effects
The Iran crisis is a turning point in global politics and will produce significant shifts over time. Some of the most likely are outlined below:
- Expect new defence alliances: The countries of the Persian Gulf have long relied on the US for protection, which has given America considerable influence in the region. However, this relationship, along with their willingness to host American military bases, has left them exposed to Iranian attacks. The US has been unable to prevent all of these attacks and seems to have failed in resupplying its allies with Patriot and other anti-missile interceptors when stocks ran low. The Gulf sheikhdoms will now need to rethink their defence strategies. Saudi Arabia’s recent alliance with Pakistan could also expand to include other regional powers, such as Turkey.
- Israel would worry the region: Once the dust settles after this conflict, Israel will emerge as the dominant power in the Middle East. If it uses this power to erode Palestinian rights further or impose its will on neighbours like Lebanon, we could see rising tensions and new crises in the region.
- More countries may seek nuclear protection: Some countries may take note that North Korea, a nuclear power, has not been targeted by the US, while Iran, which had not developed nuclear weapons, was decimated by American action, as were other non-nuclear countries like Iraq, Syria, and Libya. It would not be surprising if some countries in the Middle East and beyond decide to pursue nuclear weapons capabilities.
- Dubai’s finance and business status could be at risk: Despite its history of shrewd diplomacy, the UAE and its key cities, Abu Dhabi and Dubai, have become targets of missile and drone strikes, undermining their status as safe havens in a volatile region. Dubai, in particular, had become a global hub for finance, aviation and business. The sight of explosions near the Burj Khalifa would have shaken investor confidence. But once the conflict subsides, those concerns are likely to ease. Major hubs like Dubai are resilient and adaptable, and it’s premature to expect their role to wane in favour of cities like Hong Kong or Singapore.
A rough time ahead for Asia
The war with Iran is a pivotal moment for the Middle East, with potentially far-reaching consequences for Asia. In the short term, Asian economies will face slower growth and higher inflation. Over the longer term, they will need to brace for significant political and economic changes that could make the world a more unstable place.
Manu Bhaskaran is the CEO of Centennial Asia Advisor
