Middle East, from ratings to oil prices: the impacts of the conflict

“Although last weekend's events signal a significant increase in geopolitical risk, the central thesis of S&P's base case remains largely unchanged.you unchanged. That is, the rating agency predicts that the war between IIsrael and Hamas will continue in 2024 and that Gaza will remain the epicenter, with continued pressure on Israel (AA-/Negative/A-1+) from Iran (unrated) and its proxiesroxy”.

MO, wider conflict outside the base scenario

This is what we read in the note S&P Global Ratings commenting on the latest developments in the Middle East and the possible impacts of an expansion on a regional scale of the conflict already underway in which it is underlined that the agency also foresees that the intense diplomatic efforts and limited nature (and widely expected) of Iran's operations “will prevent the immediate crisis from escalating into a large-scale regional conflict. However, S&P believes the situation will depend on the nature and extent of the Israeli response in the coming days. A large-scale conflict between states would be economically, socially and epholistically destabilizing for the entire region and its financial markets”.

Iran's unprecedented military action against Israel – it is however specified – “increases the risk of a strong escalation of the conflict, which severely tests the limits of the basic hypotheses supporting the sovereign ratings assigned by the agency in the area”.

From ratings to oil prices

S&P – we read – takes note that the main players in the conflict and the broader diplomatic communitya have explicitly indicated that they do not want further escalation of the situation. However, the risk of tactical errors and other negative scenarios has increased. An unstable and prolonged geopolitical context is likely, characterized by periodic escalation actions by the parties to the conflictremains a reality for the region. S&P could take negative rating action if the war evolves with increasingly negative macroeconomic implications on trade, financial flows and tourism, in addition to damage to affected populations.

As for the S&P ratings on Middle Eastern sovereign issuers already take into account a certain level of regional geopolitical volatility. If a broader, prolonged conflict were to emerge – along, for example, with a prolonged closure of the Strait of Hormuz – the fiscal benefit of a potential increase in oil prices for Gulf producing countries could be offset by the inability for governments to export its hydrocarbons. This could increase their spending needs and negatively impact capital outflows, financing costs and economic growth.

The impacts

In particular, “in the adverse scenario of a prolonged conflict, S&P ratings on most regional sovereigns could come under pressure. However, in the near term, S&P expects ratings of ABu Dhabi, Kuwait, Qatar and Saudi Arabia they probably are supported from their large stocks of investable external government assets. Oman's rapid deleveraging has strengthened the bthe sovereign launch and, given its geographical location, the country is less likely to be hindered by the closure of export routes. We believe Bahrain is more vulnerable to outflows given its banking sector's high external financing needs. Further escalation could compromise social stability and security in Iraq, Lebanon, Jordan and Egypt, especially in the event of retaliatory attacks in these countries. However, the low levels of rating of these sovereign countries already incorporate a high degree of political risk and the entrenched challenges that these countries face.”

For Israel, lIran's direct attack “constitutes a further escalation of already high geopolitical risks. While the war with Hamas has been predominantly centered in Gaza since October 2023, its fallout has been increasingly felt by Israel on other fronts, including the regular exchange of fire with Hezbollah in Lebanon, Houthi attacks and now the first direct attack by Iran, following Israel's earlier reported attack on the Iranian consulate in Damascus. S&P believes that the continuing risk of a broader regional conflict could have an even more pronounced impact on Israel's economy, budget and security, compared to current baseline projections.”