(Editor's Note: In this series of articles, we answer the pressing Questions That Matter on the uncertainties that will shape 2024—collected through our interactions with investors and other market participants. The series is aligned with the key themes we're watching in the coming year and is part of our Global Credit Outlook 2024.)

Geopolitical uncertainties will affect global growth and inflation, consumer and investor confidence, trade and supply chains, and overall capital flows. These uncertainties come against a backdrop of the continuing Russia-Ukraine and Israel-Hamas wars, disputes over the South China Sea, and upcoming national elections in more than 50 countries in 2024. Government and corporate borrowers alike could continue to face elevated funding costs while interest rates remain higher for longer.

How This Will Shape 2024

The Russia-Ukraine and Israel-Hamas wars are extending into 2024 and continue to dominate much of the regional and global agendas.  The continuation of these conflicts will keep geopolitical uncertainties high.

Intensifying U.S.-China diplomatic and trade frictions, and disputes over the South China Sea, will remain a risk.  After the pandemic exposed supply chain vulnerabilities, the U.S. is likely to continue diversifying trading partners, to the benefit of Mexico, Vietnam, and other economies. Policymakers, like the leaders of the BRICS countries, have been advocating a move away from using the U.S. dollar for trade among their countries. Making supply chains more resilient to geopolitical uncertainty could boost investment locally, or in politically stable or aligned countries, while leading to economic costs that could stoke inflation.

At the same time, more than 50 countries will hold national elections in 2024.  Most prominent will be the U.S. presidential elections in November. The U.K. general elections will likely occur in late 2024 or early 2025. Across emerging market economies, national elections will take place in India, Indonesia, South Africa, India, and Mexico, among many others.

What We Think And Why

Geopolitical uncertainties affect consumer and investor confidence, trade, and capital flows.  The active military conflicts could lead to upward pressure on energy and other commodity prices, and consequently affect global growth and inflation--keeping interest rates even higher for longer. Governments and private-sector borrowers could continue to face higher funding costs. At the same time, elevated energy prices would weigh on the balance of payments of energy importers. Energy suppliers, by contrast, would likely benefit. At the same time, the sticking points of U.S.-China relations will continue to be trade, technology, and security. This geopolitical disruption, alongside other tensions, could reinforce trade fragmentation and the relocation of supply chains.

We think that the impact, including on economic growth, of the war in the Middle East can largely be contained to Israel and its nearest neighbors--for the time being.  However, the situation is fraught with risk, particularly if the ground offensive into Gaza provokes a military response from Iran-backed militant groups. We believe the conflict could increase tensions within the region, and between communities and governments around the world.

We expect the active phase of the Russia-Ukraine war to continue at least until the end of 2024.  Ukrainian forces have so far largely struggled to retake substantial swathes of territory as part of their ongoing counteroffensive. We think that the prospect of any negotiated peace plan appears almost nonexistent, and that a military stalemate remains the most likely scenario as both sides resign themselves to an extended war.

Intensifying conflicts and geopolitical disruption have implications for credit quality.  Of our 137 sovereign ratings, 14 currently have negative outlooks and 11 have positive outlooks (see chart 2). Most non-stable outlooks on sovereign ratings are in EMEA (Europe, the Middle East, and Africa), and some of them reflect those geopolitical risks, including the outlooks on Latvia, Lithuania, Estonia, and Israel. The negative outlook on Israel, for example, reflects the risk that the Israel-Hamas war could spread more widely or affect Israel's credit metrics more negatively than we expect.

Global geopolitical positioning, domestic preelection controversies, and election outcomes could affect each other.  Although election years often go hand in hand with extra fiscal spending, this could be exacerbated by the rising cost of living, as well as the vulnerabilities in access to public health services that the pandemic exposed. As the electorate has likely become more sensitive to such shortcomings, we could see fiscal slippage while government funding costs are high. These conditions would be detrimental for government finances but could temporarily create some extra demand.

Government spending could focus on garnering short-term electoral support rather than infrastructure spending that supports long-term growth.  At the same time, if a preelection phase comes with heightened polarization or uncertainties, that could affect local consumer and investor confidence.

Chart 1

What Could Go Wrong

In the Middle East, the key risk is the potential for the conflict to escalate and spread more widely in the region.  Hezbollah, for instance, could intervene more, which could risk drawing in the U.S. if Iran is viewed as having directed Hezbollah's actions. Such escalation would have significant repercussions that could extend globally, for instance on energy markets.

The tail risk for energy markets and supply chains relates to the possibility of Iran impeding transit through the Strait of Hormuz.  Saudi Arabia, the United Arab Emirates, Kuwait, Iraq, and Iran ship most of their oil exports--or the equivalent of about one-fifth of global oil consumption--and chemical product exports through Hormuz, while Qatar sends almost all of its liquefied natural gas through the strait.

Protests or refugee flows could be politically destabilizing across the Middle East, and beyond.  They could also lead to more polarized public debates on migration in Western countries, which could add to anti-globalization movements.

We also think some risk of escalation in the Russia-Ukraine war remains.  Escalation could include the use of nonconventional means, unforeseen accidents, or direct confrontation with NATO countries. An escalation would lead to renewed shocks on energy and food markets and, consequently, on inflation and growth.

Heightening disputes over the South China Sea could damage investment, trade, and supply flows within and outside the area, since some 20%-30% of global trade passes through it.  Taiwan accounts for about 60% of global semiconductor production. Given mutual dependencies between the U.S. and China, an escalation could disrupt financial markets globally. The U.S. sanctions on Russia raised questions on whether the U.S. could bring similar measures against Chinese banks. China, on the other hand, is the largest holder of U.S. Treasury bonds.

The strength of institutional frameworks could be affected if election campaigns lead to increased political polarization.  The increase in the cost of living and low growth could set the agenda of election campaigns in some countries, and lead to more lax fiscal policies and growing government debt, amid high interest rates. Leadership changes--in particular, in the U.S.--could have global repercussions, for example if the U.S. were to take a more isolationist approach.

Chart 2

Related Research

• CreditWeek: What Are The Credit Ramifications Of The War In The Middle East?, Nov. 2, 2023
• Global Sovereign Rating Trends: Third-Quarter 2023, Oct. 16, 2023
• Challenges To Trading Oil In Renminbi Remain Significant, Oct. 5, 2023