Global Economics

The Mideast's Economic Fallout


The violence along Israel's northern border with Lebanon escalated over the weekend of July 15-16, as Lebanon's Hezbollah Shiite militia launched a rocket attack on a major Israeli city and Israel bombed targets in Lebanon. The latest round of fighting began on July 12, following the kidnapping of two Israeli soldiers and the killing of seven others in an attack by Hezbollah (see BusinessWeek.com, 6/12/06, "New Fighting Spooks Investors in Israel"). The conflict has claimed dozens of lives on both sides of the border and now threatens to expand into a regional war, possibly involving Syria and Iran.

The Israeli and Lebanese economies have already been hit hard. Business activity in Lebanon and northern Israel has essentially come to a standstill. Economists say economic growth will certainly be adversely affected, though to what extent depends on the duration of the fighting. "Tourism and consumer spending have largely ground to a halt, and this will have an immediate impact on our near-term growth," predicts Leonardo Leiderman, chief economist at Bank Hapolaim, Israel's largest bank.

The expected growth in the Israeli economy in 2006 had been 5.2%. Now, however, several economists say privately that the hostilities could shave as much as two percentage points off that number. Leiderman believes it's too early to predict the economic cost with any precision.

TOURIST CANCELLATIONS. The Lebanese economy appears to be on far shakier ground. "The naval blockade is going to halt all trade to Lebanon and cause serious damage to the country's vital tourism sector if the Israeli offensive lasts very long," says Steve Brice, head of Middle East research at Standard Chartered Bank in Dubai. Before the Israeli offensive, the Bank of Lebanon was predicting 4% to 5% growth. Now, Brice believes that the Lebanese economy could actually contract.

Hotels and airlines are reporting massive cancellations. At the Pastoral Hotel at Kibbutz Kfar Blum in northern Israel, thousands usually turn up for an annual classical music festival scheduled to begin on July 20. The hotel had been booked solid. But the festival's organizers canceled the event this week, since Kfar Blum is only kilometers from the Lebanese border. The Pastoral Hotel is now essentially empty.

Shopping malls have been shut down in the northern part of Israel, and many in other parts of the country are seeing little traffic as Israelis stay home to closely follow the latest developments on TV and the radio. Just as significant is the price tag of the military operations and the damage they cause. The Israeli operation is likely to cost more than $2 billion. The initial estimates of the damage to Lebanon's economy from the Israeli air attacks and naval blockade are upwards of $500 million.

HIGH-TECH FEARS. There is even concern in Israel's booming high-tech industry, which has been largely insulated from regional developments. "Foreigners are canceling visits here, and we have to schedule meetings abroad to conduct our business," says Carmel Sofer, general partner at Gemini Israel Funds, a Herzliya-based venture-capital fund. If the conflict is of short duration, Sofer believes the impact will be minimal, but the longer it goes on the greater the damage will be.

Microsoft (MSFT) and Intel (INTC) both have development centers in Haifa, a northern Israel city that was hit by Hezbollah missiles over the weekend. Microsoft, which employes 180 at its Haifa development center, told its workers by e-mail that they didn't have to come in to work, though they could work from home. The 2,000 employees at Intel's research and development facility in the city did show up for work on July 16, a regular work day in Israel, though they worked on wireless PCs that allow them to remain in the safer sections of their facility.

Despite the avalanche of bad news on Sunday, July 16, the Tel Aviv Stock Exchange actually rallied for the day. The market fell sharply at the open with the reports of the rocket barrage on Haifa, but later staged a recovery as the closely watch TA-25 index closed up 3.2%.

STRONGER SHEKEL. In the two previous days of trading the market fell by more than 8%. The tumult hit companies such as Bezeq Telecom (BZQIF.PK) and Bank Hapoalim (BKHYY.PK). One question is whether foreign investors, who have been flocking to Israeli stocks, will maintain their interest in the face of the stepped-up hostilities. Many of the largest Israeli companies by market capitalization also trade on U.S. exchanges, including Teva Pharmaceuticals (TEVA), Partner Communications (PTNR), Nice Systems (NICE), Koor Industries (KOR), and Blue Square Israel (BSI).

On July 16, the shekel also recovered against the dollar. "Investors are apparently willing to gamble that the worst is already behind us," says Shay Yaron, senior vice-president at Psagot Ofek, a Tel Aviv investment bank. One of the factors that led to the rebound was a report by Fitch Ratings that predicted only limited short-term fallout for Israel from the conflict.

Lebanon may not get such a reassuring assessment. The naval blockade will force the country to pay a hefty premium to import goods via Syria. The tourism industry was expecting its best ever season, with the number of visitors up by an astonishing 50% in the first six months of the year. The Lebanese Tourism Ministry was counting on a record 1.6 million visitors to spend $2.5 billion. The U.N. estimates that tourism accounts for 15% of Lebanon's gross domestic product. Tens of thousands of tourists from the Gulf region were forced to flee to neighboring Syria when Israel bombed the Beirut Airport at the beginning of its military operation.

BLOW TO LEBANON. Beirut was also enjoying a property boom in the past year, as prices soared by an average of 50%. Billions of dollars have been invested in redevelopment projects in the Lebanese capital's downtown.

The Lebanese economy is already vulnerable. It is saddled with $40 billion foreign debt, equivalent to 180% of GDP.

The Israeli offensive sent stocks plummeting on the Beirut bourse, which posted a decline of nearly 15% last week. In an effort to stem the selloff, the Beirut Stock Exchange approved a new temporary daily limit on the amount the market can move in either direction. The percentage change was reduced to 5% from the previous 10%. The change goes into effect when trading resumes on July 17.

So far direct damage has been limited to the Israeli and Lebanese economies but experts say that this could change quickly if other countries in the region are drawn into the conflict. The repercussions could go far beyond the Middle East. Israeli energy consultant Amit Mor does not rule out a scenario in which Iran curtails oil production if there is a further escalation in the fighting, as a means of putting pressure on the West to rein in Israel.

Such fears have helped push oil prices to record highs. Prices briefly hit $78 a barrel on July 14, as troubles in Israel, Iran, and Nigeria all contributed to uncertainty about the supply of oil from various regions. Surging oil prices contributed to the triple-digit declines in the U.S. stock market three days in a row last week. Investors at stock markets in the Middle East have also been spooked. Egypt's Hermes index dropped by 4.8% on July 16, and Qatar's QSI index closed down just over 6%. Most bourses in the Gulf traded lower on Sunday, though the Saudi market rebounded by 3.4% after falling by more than 9% on July 15.


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