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For more vulnerable economies, including debt-stricken countries in Asia and some small Pacific Islands, a prolonged global energy shock might necessitate seeking emergency external support (Ina Fassbender/AFP via Getty Images)
The Iran war isn’t just a Middle East crisis.
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The economic fallout of the Iran war for Indo-Pacific developing countriesThe economic fallout of the Iran war for Indo-Pacific developing countries
Disruption to global oil and gas supplies caused by the Iran war has sent policymakers worldwide into a tailspin. None more so than in the Indo-Pacific where many developing countries are large net energy importers.
Shipping through the Strait of Hormuz has slowed to a crawl, choking off around one-fifth of global oil and LNG seaborne supplies. Iranian projectiles have hit major oil and gas facilities across the region, including Saudi Arabia’s largest refinery and Qatar’s largest LNG export facility. World oil prices have spiked past the $100 a barrel marker and may go considerably higher depending on how long the war drags on. LNG prices have also surged.
The basic economics of a supply-driven energy price shock are well known. Higher energy prices are “stagflationary”, simultaneously pushing up inflation and depressing economic activity, leaving central banks with no good options in managing the macroeconomic impact. Even countries that are net oil and gas exporters (benefiting from increased energy prices) must nonetheless grapple with higher inflation and pressure on other parts of the economy outside of oil and gas. As the shock is global, demand for non-energy exports will also weaken.
Small island developing states are amongst the most heavily reliant on imported fuel and therefore the most acutely vulnerable in the region. Net oil and gas imports are generally between 5–15% of GDP among Pacific Island countries and 10% of GDP in the Maldives. Thailand, Laos, Cambodia, Nepal, and Pakistan are the next most exposed, with net oil and gas imports equal to 5–8% of GDP. Most other Indo-Pacific developing economies are however also significant net oil and gas importers and will therefore suffer from higher global prices. Only Papua New Guinea and Timor-Leste are net energy exporters amongst lower income countries, as are higher income Malaysia and Brunei.
As the old global order crumbles, the Iran war is only the latest in what are becoming ever more frequent international economic shocks.
The impacts are not confined to energy. Fertiliser costs are also spiking higher, both as the Middle East and the Strait of Hormuz are a major source of global fertiliser supply but also as natural gas is a critical input into fertiliser production. Higher global food prices will result, potentially precipitating its own crisis. International flights and shipping are also being disrupted and face higher costs, with flow-on effects for global trade and tourism.
Again, it is small island developing states such as those in the Pacific that are among the most exposed due to their heavy reliance on imported food and other goods while the international tourism industry is often vital for income and employment. Countries such as Cambodia, Thailand and Nepal are again among the most exposed among others due to their reliance on tourism and manufacturing exports.
Shipping through the Strait of Hormuz has slowed to a crawl, choking off around one-fifth of global oil and LNG seaborne supplies (Fadel Senna/AFP via Getty Images)
Higher global interest rates as central banks and bond markets react, combined with a “risk-off” response from investors, could also result in capital flight from the region’s emerging and frontier economies – putting pressure on exchange rates and renewing problems for already debt-stricken countries like Laos, Sri Lanka, Pakistan, and Bangladesh.
Beyond the obvious immediate threat, the deeper challenge for policymakers is dealing with an increasingly shock-prone world. As the old global order crumbles, the Iran war is only the latest in what are becoming ever more frequent international economic shocks – from the Covid-19 pandemic to Russia’s invasion of Ukraine to Donald Trump’s ongoing tariff war. To this can be added increasingly devastating climate events such as Cyclone Senyar that killed 1,600 people in South and Southeast Asia late last year and the twin cyclones (and earthquake) that hit Vanuatu in 2023.
What can policymakers do? No one knows how long and far this energy price shock will go. It is possible it will be short lived. Or not.
Policymakers in countries with more policy space (i.e. less inflation and debt) have more scope to “look through” the impact as a one-off shock, allowing for more substantial monetary and fiscal support. Though care will still be needed – in an increasingly shock-prone world, macroeconomic policymakers could quickly find themselves with ever less policy space.
For more vulnerable economies, including debt-stricken countries in Asia and some small Pacific Islands, a prolonged global energy shock might necessitate seeking emergency external support from the International Monetary Fund and other multilateral and bilateral partners.
Social protection systems are emerging but mostly under-developed across Indo-Pacific developing countries. Many in Asia have existing energy subsidies or price controls in place. Ideally the Iran energy shock could serve as a catalyst for reform, shifting away from inefficient and costly energy subsidies – that promote fossil fuel consumption and mostly benefit better-off households – towards means-tested social protection for the most vulnerable people.
Indonesia’s government for instance has said it will not yet adjust retail energy prices but flagged it may need to if high oil prices persist. In the past, oil price spikes have provided the catalyst for the government to cut fuel subsidies while providing offsetting social protection payments to protect lower-income households.
More generally, an increasingly shock prone world puts priority on building out the region’s social protection systems to be more robust, comprehensive, and well-funded.
Similarly, the Iran war only increases the importance of accelerating the transition to clean energy, as a way of reducing exposure to future oil shocks. That will be difficult amid an ongoing economic shock. But a crucial medium term policy agenda that should not be deterred.
About the author
Roland Rajah
Roland Rajah is Lead Economist and Director of the Indo-Pacific Development Centre at the Lowy Institute, focusing on economic development challenges across Southeast Asia, the Pacific Islands, and South Asia. His research spans macroeconomics, aid and development finance, geoeconomics, and regional integration.
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