This report does not constitute a rating action.
Key Takeaways
- The Israel-Hamas-Hezbollah conflict has caused significant human tragedy, but the impact on sovereign credit metrics has so far been limited to the two rated sovereigns involved: Israel and Lebanon.
- We continue to assume a protracted, direct Israel/U.S.-Iran conflict will not emerge.
- However, the recent further cycle of escalation means we now think it likely that the conflict will persist into 2025, with greater potential for developments that could weigh on regional sovereign credit ratings.
- We assess the current regional stress level as moderate but with elements of high stress potentially emerging; see descriptors below.
Since mid-September 2024, Israel's military focus appears to have moved away from Gaza to further north. We have seen an upsurge in Israel fighting against Hezbollah in Southern Lebanon and Beirut, and Iran's subsequent retaliatory missile attack on Israel. This signifies a further intensification of the war ongoing since October 2023, beyond our previous expectations. Consequently, in our view, the risk of broader regional ramifications for sovereign creditworthiness is worsening.
Recent Escalations Are Heightening Broader Regional Risks
The recent intensification of hostilities between Israel and Hezbollah, including the former's ground invasion of Southern Lebanon, has increased the potential for a more intense and damaging action-and-reaction cycle between Israel and Iran. In turn, this could broaden and drag more countries into conflict. Iran's Oct. 1 missile attack on Israel--in response to several allies being killed and associated military infrastructure damaged--demonstrated a greater retaliatory force than in its April attack. Still, while direct hostilities between Iran and Israel are poised to increase, we believe the economic and security consequences--and public statements by Iran implying limited appetite for a highly destabilizing direct military engagement with Israel--will ultimately limit the extent of Iran's direct responses and preclude intensified direct conflict. However, much will also depend on Israeli actions and the capacity of all the actors in the conflict to avoid mistakes or miscalculations.
We assess regional stress levels as moderate, with elements of high stress potentially developing (see table below). So far, the sovereign credit impact of the conflict has been confined to the two rated sovereigns directly involved in the conflict: Israel and Lebanon. However, we now foresee several potential pathways via which the conflict could have a more material credit impact on the rest of the region, described below. While our sovereign ratings in the region already factor in the temporary emergence of geopolitical stress, we see several transmission channels--including changing energy prices, trade-route security, tourism revenue, remittances, and the potential for capital outflows--that could affect countries in the region in different ways. Some sovereigns would be more/less sensitive to certain stresses than others, meaning that some elements of the below scenarios could be present in one country and not another (see Related Research).
Our rating on Israel is now two notches lower than on Oct. 7, 2023, reflecting weaker fiscal and growth expectations through 2025, as well as significantly increased security risks. Although Lebanon remains in default, we believe its economic and recovery prospects have also been weakened. Here, we briefly summarize a series of hypothetical, progressively worsening regional stresses.
| Possible Regional Stress Scenarios | |||
|---|---|---|---|
| Modest Stress | Moderate Stress | High Stress | Severe Stress |
| In this scenario, the current intensification of direct, inter-state hostilities between Iran and Israel would remain short (less than three months). The ground invasion by Israel into Lebanon diminishes threats from Hezbollah. Attacks, including from proxy forces, on Israeli and allied regional assets are short-lived. Limited impact on credit metrics for the wider region. | In this scenario, a series of escalatory attacks between Israel and Iran threaten wider regional security but ultimately settle, in a time period somewhat beyond that in the Modest Stress scenario. Impacts on economic growth, energy prices, and key trade routes are manageable and temporary with limited impacts on fiscal and external credit metrics. | In this scenario, persistent and intense cycles of attacks between Israel and Iran develop, implying a material impact on macroeconomic stability for the wider region. This includes more prolonged blockages to trade routes, which could engender a response from non-regional actors, and a greater stress on transmission channels such as energy prices, security expenditure, tourism flows, and capital outflows. | In this scenario, regional and non-regional allies are drawn into the conflict, including Iran and its supported forces, the U.S., and Gulf allies. This results in material increases in energy prices and risks to export volumes because of persistent threats to trade routes; lasting impacts on regional macroeconomic stability; and greater stresses on sovereigns' fiscal and external metrics. |
Increased Proxy Activity Could Threaten The Wider Region
We view the likelihood of a protracted, direct conflict between Iran and Israel/the U.S. as limited, but it now appears more likely that regional military forces aligned with Iran will seek to inflict damage on Israel and its allies' assets and to bolster perceptions of their combined regional military clout. This aligns with our moderate stress scenario. Iran-supported military forces predominantly based in Iraq, Syria, and Yemen have frequently sought to disrupt commercial economic interests to these ends.
Related conflict has encompassed proxy strikes throughout the region, typically involving actions or threats that could block or hamper shipping through globally significant economic and trade routes, including the Strait of Hormuz and Bab Al-Mandeb, the former being the passageway for the equivalent of about 25% of daily global oil production. Such trade disruptions could be a key challenge for the region, with the potential to increase oil prices and pose fiscal risks to energy importers, although higher oil prices could mitigate the risk for Gulf exporters particularly if the risks of export routes being blocked--or oil production facilities being disrupted--remain contained. In 2019, an oil processing facility in Saudi Arabia was attacked, temporarily cutting off about 50% of Saudi oil production (about 7% of global daily production). We currently see a low likelihood of direct attacks on oil production facilities in the region given the recent relatively-improved relations between Iran and the GCC.
We now also view additional transmission channels for economic disruption as more likely to be stressed, but remain manageable. Overland trade routes, fiscal costs (security for example), population displacement/movements, and tourism flows are all now potentially more vulnerable.
Israel's conflict with Hezbollah in Lebanon could also end up being more protracted than anticipated, with implications for Lebanon and perhaps the broader region. Given the reported sophistication of Hezbollah's military capabilities, proxy forces may have scope to initiate attacks against Israel and increase the potential for a miscalculation that could widen the geographical perimeter of direct military engagement. We would assess this scenario as more akin to high stress.
We anticipate bouts of regional political volatility, increasing risks of credit disruption
We will continue to monitor developments and their potential impact on our sovereign ratings in the region. That said, we already factor into our ratings our expectations of bouts of regional geopolitical turbulence that will temporarily impact countries' credit metrics. Still, with these developments, we consider that material economic disruption has intensified for Israel and Lebanon, and could increase for the wider region, potentially seeing downward rating pressure emerge. Further, we now view the conflict as more complex and unpredictable and consider it more likely to persist well into 2025, with potentially lingering aftereffects.
Related Research
- A Prolonged Israel-Hezbollah Conflict Bears Long-Term Socioeconomic And Security Risks For Lebanon, Oct. 3, 2024
- Israel Long-Term Ratings Lowered To 'A' From 'A+' On Heightened Security Risk; Outlook Negative, Oct. 2, 2024
- Israel Long-Term Ratings Lowered To 'A+' From 'AA-' On Heightened Geopolitical Risk; Outlook Negative, April 19, 2024
- MENA Tourism Likely To Take A Hit From Israel-Hamas War, Nov. 6, 2023
- Israel Outlook Revised To Negative On Geopolitical Risks; 'AA-' Ratings Affirmed, Oct. 25, 2023
- Saudi Arabia Outlook Revised To Positive On Sustained Reform Momentum; 'A/A-1' Ratings Affirmed, Sept. 14, 2024
- Jordan Upgraded To 'BB-' On Economic Resilience; Outlook Stable, Sept. 7, 2024
- What A Regional Escalation Could Mean For MENA Banks' External Funding, Nov. 13, 2023
- War In The Middle East Compounds Global Geopolitical Risks, Oct. 18, 2023
- GCC Sovereign External Balance Sheets Remain Strong Despite Higher Banking Sector External Debt, Nov. 13, 2023
- Why GCC Banking Systems Are Resilient To Geopolitical Stress Scenarios, June 22, 2022
- Attack On Saudi Aramco Highlights Risks To Oil Capacity And The Sovereign's Geopolitical Vulnerabilities, Sept. 16, 2019
- Credit FAQ: A Sharp Increase In Geopolitical Risk Could See GCC Banks Require Sovereign Support, July 8, 2019
- Credit FAQ: How U.S.-Iran Tensions Might Affect Gulf Sovereign Ratings, June 11, 2019
| Primary Credit Analyst: | Benjamin J Young, Dubai +971 4 372 7191; benjamin.young@spglobal.com |
| Secondary Contacts: | Zahabia S Gupta, Dubai (971) 4-372-7154; zahabia.gupta@spglobal.com |
| Dhruv Roy, Dubai + 971(0)56 413 3480; dhruv.roy@spglobal.com | |
| Christian Esters, CFA, Frankfurt + 49 693 399 9262; christian.esters@spglobal.com | |
| Additional Contact: | Sovereign and IPF EMEA; SOVIPF@spglobal.com |
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