Can the Israeli and Iranian economies survive a war?

Escalating conflict between Israel and Iran is posing significant economic challenges for both nations, with Israel already facing substantial costs from its ongoing operations in Gaza, estimated at $67.5 billion by the end of 2024, and a potential $1.45 billion in the first two days of fighting with Iran alone; S&P Global Ratings warns of a potential credit downgrade for Israel if the conflict continues. Meanwhile, Iran's oil exports have plummeted, with exports from Kharg Island ceasing entirely, and the country's economy continues to suffer under existing sanctions, leading to reduced foreign exchange earnings and infrastructure challenges, potentially straining its ability to finance a prolonged war effort despite having $33 billion in foreign exchange reserves.

Analysis

The escalating military conflict between Israel and Iran is exacting a substantial economic toll on both nations, threatening their fiscal stability and growth prospects. Israel, already burdened by the Gaza conflict which is projected to cost $67.5 billion by the end of 2024, faces an additional estimated $1.45 billion for just the initial two days of hostilities with Iran, potentially surpassing the Gaza war's expenses within seven weeks if prolonged. This has necessitated a significant increase in Israel's defense budget, from $17 billion in 2023 to a projected $34 billion in 2025, risking a breach of its 4.9% GDP deficit ceiling and contributing to a downward revision of its 2025 growth forecast from 4.3% to 3.6%. S&P Global Ratings has issued a warning that a sustained war could lead to a credit rating downgrade for Israel from A to A-, potentially increasing borrowing costs and dampening investor confidence. Concurrently, Iran, already weakened by years of international sanctions that have severely curtailed its oil export revenue to approximately 200,000 bpd ($50 billion over 2022-2023) and caused its currency, the rial, to lose over 90% of its value against the dollar since 2018, is now experiencing direct attacks on its critical energy infrastructure. Reports indicate a complete halt in oil exports from Kharg Island, its primary export terminal, and partial suspension of production at the vital South Pars gasfield, which accounts for 80% of Iran's gas output. Despite possessing $33 billion in foreign exchange reserves, Iran's capacity to fund a protracted conflict is severely constrained by high inflation (officially 40%, potentially over 50%), significant poverty levels with 22-27% of Iranians below the poverty line, and the risk of long-term economic crippling if these reserves are depleted for military purposes.

Key Decisions for Investors

• Investors should closely monitor S&P Global Ratings' assessment of Israel's creditworthiness, as a downgrade to A- would likely increase sovereign borrowing costs and negatively impact Israeli financial assets.
• Given the significant disruption to Iran's oil and gas infrastructure, including the halt of exports from Kharg Island and damage to the South Pars gasfield, investors should anticipate heightened volatility in global energy prices and assess potential impacts on energy-related investments.
• Consider reducing exposure to assets directly linked to the Israeli and Iranian economies due to the severe fiscal strains, declining growth forecasts for Israel, and the precarious economic conditions in Iran, which are all exacerbated by the escalating conflict.
• Evaluate portfolio companies for indirect exposure to the region, particularly those with significant supply chain dependencies or operations, as prolonged conflict could lead to broader economic disruptions and increased operational risks.