A sharp rise in geopolitical risk and the Israel-Gaza war turning into a regional conflict involving Iran and Hezbollah would severely dent the economic prospects of both Lebanon and Israel and will further slow growth in Tehran's sanctions-hit economy, analysts say.
Lebanon, whose economy is already reeling amid years of political stalemate, is likely to take the worst hit, with its gross domestic product shrinking significantly should a full-scale armed conflict spill into its borders.
“Based on the Israeli threats of destroying vast parts of Lebanon’s infrastructure, and punishing the Lebanese state, I forecast a contraction of 10 per cent to 15 per cent this year,” Nassib Ghobril, head of group economic research at Beirut headquartered Byblos Bank, said.
Geopolitical risks have risen sharply in the Middle East since the killing of Hamas political leader Ismail Haniyeh in Tehran early on Wednesday, hours after Israel struck a south Beirut suburb, killing Hezbollah commander Fouad Shukr.
Mr Haniyeh was in Tehran for the inauguration of Iranian President Masoud Pezeshkian when he was killed, along with his bodyguard. This led to vows of retaliation against Israel from Iran's supreme leader.
While Israel has said it killed Mr Shukr, it has not admitted to assassinating Mr Haniyeh.
The assassination of Mr Shukr came days after a rocket hit a football field in Majdal Shams in the occupied Golan Heights, killing 12 children. Israel claims Hezbollah has carried out the strike, but the Lebanese group has denied responsibility.
Mr Haniyeh's funeral procession began on Thursday in Tehran and he will be buried in Qatar on Friday.
Following the funeral of Mr Shukr in Beirut, Hezbollah leader Hassan Nasrallah said Israel had crossed a red line and the assassinations would usher in a “new phase” of fighting that would make Israel “weep”.
Israeli Prime Minister Benjamin Netanyahu on Thursday said the military is ready to respond to retaliation for the killings.
“Israel is at a very high level of preparation for any scenario, both defensive and offensive,” Mr Netanyahu said.
The likely scenario
Analysts say the region will likely be able to avoid a full-scale war. However, if the tensions are not dialled down and the worst fears materialise, economies in the broader Middle East and North Africa region will bear the burnt.
“I don't think Iran currently has the ability for a full-scale war with Israel and its allies,” said Naeem Aslam, chief investment officer at Zaye Capital Markets.
“Speaking from the markets perspective, we do not really think that there is an actual risk that the markets are pricing in, in relation to a full-blown war taking place in the Middle East.”
The latest incidents have hampered efforts to reach a ceasefire between Hamas and Israel to halt the war in Gaza.
“It doesn't help,” US President Joe Biden told reporters, when asked if Mr Haniyeh's assassination would ruin the chances of a truce.
If diplomacy fails, the escalatory confrontation between Israel and Hezbollah will deteriorate into a sustained Israeli operation in Lebanon, which could turn into a regional conflict, S&P said.
“In the event of a regional war escalation, we would expect to see co-ordinated attacks against Israel and US regional forces from Iran, Lebanon, Syria, Iraq, Yemen and the Palestinian Territories,” said Jack Kennedy, head of Mena country risk at S&P Global Market Intelligence.
Disaster for the Lebanese economy
Lebanon has seen proxy wars and armed conflicts over the past decades, however the current state of its economy puts it at the risk of a “complete collapse”, Mr Aslam said.
But while an aggravated military conflict between Israel and Hezbollah will spell disaster for the economy, the scale of the damage will be limited.
“The impact will not be anything like what happened in Palestine. I don't think that anyone who's looking at this scenario currently thinks that. It is going to be very much contained,” said Mr Aslam.
In escalation scenario, the probable first-line Lebanese targets could include Hezbollah military assets in or near critical infrastructure such as Beirut-Rafic Hariri International Airport and Beirut seaport, as well as Sidon, Tyre and all the smaller ports in southern Lebanon, S&P said.
The country's economy is estimated to have already suffered damages worth $1.5 billion due to the war, according to local media reports.
Lebanon is already grappling with what the World Bank has called one of the worst global financial crises since the middle of the 19th century.
The banking sector is facing more than $70 billion in losses and its currency has lost more than 90 per cent of its value since 2019, when the country defaulted on its debt for the first time in its history.
Mr Ghobril said the scenarios of the conflict remaining at the Lebanese border with Israel at the level it has been at since October 2023, or spreading out into the rest of the country, have 40 per cent to 45 per cent probability each.
The likelihood of an early and sustained ceasefire is only 10 per cent to 15 per cent, but if that happens it would provide “a positive shock, lift the veil of uncertainty, trigger the reconstruction of the damaged areas in Southern Lebanon, and encourage visitors and tourism activity”, he said.
Blow to Iran
Iran traded direct military blows with Israel when it launched a barrage of missiles on Israel in April in retaliation for an air strike on its diplomatic compound in Syria. Tensions were dialled down without further tit-for-tat attacks and after the sudden death of conservative Iranian president Ebrahim Raisi, reformist Mr Pezeshkian took power in Tehran.
While he won the electoral race on promises of economic reforms, the killing of the Hamas political leader in Tehran has dealt a blow to his plans of engaging with the West and freeing Iran from the burden of sanctions that has crippled its economy.
A retaliation against Israel by Tehran will hamper its efforts to strengthen trade and economic ties within the region as well as internationally to boost investment into sectors such as renewable energy and its oil and gas infrastructure.
Iran's economy has suffered under extraneous sanctions reimposed by Washington in 2018 after former US president Donald Trump removed the US from the Joint Comprehensive Plan of Action nuclear deal that could have provided relief to Tehran in exchange for limiting its nuclear enrichment programme.
Reviving the 2015 nuclear accord and pursuing reforms to support economic growth in the country are the top priorities for the new Iranian president.
“Iran's fear is that it will put back hopes for some relief from the sanctions. With a new President at the helm, there were some market hopes for a more modest relaxation of sanctions over time,” Gary Dugan, chief executive of The Global CIO Office, said.
“Any escalation of troubles can only lead to a potential tightening rather than a loosening of sanctions.”
Iran’s economy has continued to grow in the past few years, with GDP hitting 4.7 per cent last year. However, growth is expected to slow 3.3 per cent this year and 3.1 per cent in 2025, according to estimates by the International Monetary Fund.
Chronic inflation is a major economic challenge for Iran. Consumer prices which hit 45.8 per cent last year, have remained above 20 per cent over the past four decades. It is expected to slow down to 37.5 per cent this year, according to the IMF.
Israel's economy under pressure
Israel's economic growth has slowed since it has launched its offensive in Gaza after the October 7 attacks by Hamas-led militants on Israeli communities in which 1,200 people were killed and 240 abducted. Israeli strikes and its ground offensive in Gaza have killed almost 40,000 people.
Israel has been forced to borrow to foot its war in Gaza, and a full-blown multifront conflict will further stress its exchequer.
“We have already seen that domestic borrowing has increased to finance the budget deficit and so any escalation of the conflict will cause further debt issuance,” said Elliot Garside, economist at Oxford Economics.
“One likely consequence of this is that Israel's credit rating will be downgraded again, making it both more difficult and more costly to finance future deficits.”
In July, Bank of Israel downgraded the country’s growth outlook from its April estimates because of the impact of the war in Gaza, with a “long way to go” before its economy can resume normality.
The Israeli economy is now expected to grow by 1.5 per cent in 2024 and by 4.2 per cent in 2025, with the central bank's projections cumulatively 1.3 percentage points lower than the April forecast.
The sluggish pace of growth assumes that the war’s direct impact on the economy will continue until the beginning of 2025, Bank of Israel said at the time.
In its earlier estimate, the Israeli banking regulator said the estimated cost of the conflict for the period between 2023 to 2025 stands at about 255 billion shekels or 13 per cent of the 2024 forecast GDP, which includes both higher defence and civilian spending, as well as lower tax revenue.
“Broader potential attacks on Israel may only worsen a deteriorating economic situation. The country is running a significant budget deficit, which can only get worse if it has to fight a more intensive [military] campaign,” Mr Dugan said.
“There are also signs of international companies delaying their investment in the country.”
Tourism, shipping and oil hit
The war spilling into Lebanon and Iran will hit investor confidence in the region and will affect sectors from tourism and shipping to retail and real estate, analysts said.
Tourism and agriculture have been hit particularly hard by the fighting in Lebanon. A number of countries have already issued travelling advisories to their citizens against travelling to Lebanon, Israel and the bordering Jordan and Egypt.
On Thursday, Air Algerie, Algeria's national carrier, said it is suspending all flights to and from Lebanon until further notice.
Tourism accounts for about 12 per cent to 26 per cent of the current account receipts for Lebanon, Jordan and Egypt, and the sector could lose about $16.1 billion in tourism revenue due to the war, according to S&P estimates.
“The travel and tourism, transport and retail sectors will be hit the most if a wider conflict arose,” Maya Senussi, Lebanon economist at Oxford Economics, said.
“Given the tourism sector is still suffering from the ongoing conflict and that tourist arrivals are at very low levels, the likely impact will be seen by a delay to the recovery.”
Yemen's Houthi militia, which has been attacking commercial vessels in the Red Sea in retaliation for the Gaza war, has also vowed to intensify its campaign in the vital global trade corridor.
“Houthi attacks against shipping in the Red Sea would probably escalate with more frequent use of uncrewed surface vessels and/or uncrewed underwater vehicles, increasing the likelihood of significant hull damage and sinkage,” Mr Kennedy of S&P said.
“These attacks would extend into the Arabian Sea/Indian Ocean and the Mediterranean, significantly increasing the risk of damage and disruption to commercial shipping and deployed naval support.”
The biggest economic threat that is likely to emerge from Iran's direct involvement in the conflict will be a spike in oil prices and increased market volatility, which has consequences for the global economy, analysts said.
A rise in global crude prices, will put the “question of inflation back on the table”, Mr Aslam said.
