Amid the escalating Middle East conflict, economists are assessing the potential impact on global markets, with China emerging as one of the losers. The immediate effect is seen in the market reaction, as investors seek safe havens like the dollar and gold while stocks plummet. This leaves smaller economies, particularly those with limited foreign exchange reserves, in a vulnerable position.
The primary transmission mechanism to the global economy is through oil. Brent oil prices have rallied by 13% to above $82 per barrel, reaching their highest point since January 2025. West Texas Intermediate was trading near $72 in early Asian markets on Monday. These price fluctuations are primarily due to Iran's role in global oil supply.
Iran accounts for approximately 5% of global oil production, and a complete outage could result in a 20% increase in oil prices, according to Ziad Daoud and Dina Esfandiary from Bloomberg Economics. Moreover, around 20% of global oil supply transits through the Strait of Hormuz, and any disruption could lead to a significant spike in prices, potentially reaching $108 per barrel.
If these higher oil prices persist, major importers like China, Europe, and India will face challenges. On the other hand, exporters such as Russia, Canada, and Norway may benefit. The US, despite being an oil exporter due to shale production, will see consumers suffer from higher fuel costs, squeezing incomes. However, the overall economy may face less drag in this scenario.
The situation is further complicated by the potential escalation of Iran's response, as noted by Bloomberg Economics analysts. Iran, despite not matching the US's military superiority, can impose significant costs and seek to bog the US down in the region. This adds to the existing uncertainty in the global economy, which has already been grappling with Trump's trade war and the impact of Artificial Intelligence on labor markets.
Chinese refiners, heavily reliant on Iranian oil, could face disruptions if Iranian barrels are affected. This is because they import an estimated 99% of Iranian exports, which is equivalent to about 13% of Chinese seaborne crude imports in 2025. As a result, China would lose another source of cheap barrels, and Russia might benefit from increased demand for heavily discounted Urals, easing some pressure on the Kremlin from decreased crude pricing.
The recent military strikes on Iran by the US and Israel, which resulted in the death of the Islamic Republic's Supreme Leader Ayatollah Ali Khamenei, have sparked concerns. Chinese Foreign Minister Wang Yi described the action as 'unacceptable' and 'instituting regime change.' This development comes at a critical time, just a month before President Xi Jinping is set to host Trump in Beijing. Any deterioration in US-Chinese ties could disrupt the trade truce, causing further uncertainty for investors on both sides of the Pacific Ocean.
In response to the market upheaval, countries with fewer buffers, such as Argentina, Sri Lanka, Pakistan, and Turkey, may face heightened risks of sudden capital outflows and currency depreciation, according to Citigroup analysts. Turkey, in particular, is vulnerable to market sentiment swings due to its trade links with Iran. As a result, the Turkish central bank has suspended its one-week repo auctions to shield the currency.
Central banks, for now, are likely to adopt a measured approach. The near-term challenge is the broad-based increase in global uncertainty, which may impact the demand side of the economy and inflation expectations. This situation calls for patience initially but a willingness to react if and when the Middle East situation stabilizes.
