The war in Gaza and Country Risk in MENA

The war in Gaza will likely drag onto the spring, when Hamas military capacity will be structurally broken though perhaps not eliminated.  Attention will then switch to the post war environment where Israel’s initial ideas focus on a continued Israeli military presence; no settlers and a multinational rebuilding fund.  What is unclear is who would have political control, which could slow or stop the rebuilding and recovery process.  The West Bank has also seen an outbreak of violence on both sides, which will likely sour the relationship between Israel and Palestinian authority that partially governs the West Bank.  Moreover, though the EU will back an Arab/EM push for a post war two state initiative and the formation of a Palestinian state, the U.S. will not want to make any commitments until after the November 2024 elections. In 2025, U.S. opposition to the two state idea could continue, which would deflect pressure on Israel – domestic Israel politics argue it could be years before this is accepted by an Israeli government.  All of this means that ongoing instability in the region centered on Gaza.  However, Iran appears to want to avoid major escalation, as this could suck the U.S. back into the region and curtail the pivot towards Asia.  Intermittent trouble can be seen from Houthi attacks on Red Sea shipping, but this is likely to become less frequent when the war ends.

Still a major political power in the region, Iran struggles with its economy, which is in a difficult shape due to sanctions and geopolitical tensions. Annual inflation rate rose by 39.2% in November of 2023, compared to the same month of 2022. The ongoing economic crisis continues to also fuel anti-regime protests and workers' strikes. Outside of Gaza, on the political front, Sunni Muslim Arab states Saudi Arabia and Egypt are nominally maintaining better relations with Iran despite differences, with Saudi Arabia and Iran having restored diplomatic ties last April. Re-establishing relations is largely a de-escalation however rather than a larger swing to close relations with other Arab nations.  Iran will not want to dilute its military strength on the de-escalation alone. Additionally, the U.S. presidential elections in November 2024 will be important for Iran’s future relations with the Western block. 

For Saudi Arabia, the focus is on pressurizing for peace and eventually a two state deal, but avoid a wider conflict in the Middle East.  On the economic front, the economy continues to remain contingent upon the revenues from fossil fuels, as the shipments of oil account for 87% of total exports and for 46% of GDP. The economy shrank in 2023, as GDP contracted by 3.2% on the quarter in Q3 of 2023, following a 0.5% fall in the previous quarter, due to OPEC+ and voluntary oil production cuts. Even so, the government remains highly committed to the 2030 program vision, which provides dual support through infrastructure spending but also a desire to reform.  Saudi Arabia launched a new residency program on Jan. 11 aimed at attracting skilled professionals and investment as the country forges ahead with its plan to pivot its economy away from fossil fuels.

In Egypt the re-election of president Sisi in December has been followed by measures to reduce the budget deficit, but scarce FX reserves; an exchange rate already 30% overvalued and the prospect of 30% inflation in 2024 are severe challenges.  The government also want to increase the USD 3 bln loan from the IMF.  The strategy will likely involve gradual devaluation over the next two years to avoid boosting inflation too much or causing popular protests against inflation.  However, the economic fallout of the war in Gaza is to reduce tourism revenue by around 20%. Though the war may only last a few more months, the instability in Gaza will likely impact Egypt tourism throughout 2024.  This means growth will likely undershoot the IMF 3.6% forecast for 2024, the current account deficit will be wider than 2.4% of GDP and budget deficit progress will likely be worse than expected.  This also means that the risk of external debt restructuring remains high in 2024 and more so in 2025.  In terms of Gaza geopolitics, President Sisi approach has been to pressure rather than confront Israel and ensure that Palestine citizens stay in Gaza to increase post war pressure for a two state solution. This has been popular in Egypt in the last few months and will likely remain the government’s stance through 2024.