How Much Will the Iran Conflict Hurt the Global Economy?

Introduction to FP Live

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0:33This is FP Live.

Strait of Hormuz Closure

0:38So the closure of the Strait of Hormuz is like a ticking time bomb for the global economy. Regular FP listeners know why. It is a serious disruption to the flow of a fifth of the world's oil and natural gas. It is hitting key inputs for low-tech goods like fertilizer and clothing, but also very high-tech ones like semiconductors. We know intuitively that the longer the standoff with Iran continues, the worse it gets for the global economy.

1:08Well, now there's some data to prove the point. The International Monetary Fund has cut its forecast for global growth this year from 3.4% to 3.1%. But those projections came out two weeks ago and were based on the conflict resolving quickly, a very optimistic scenario that has, of course, not yet come to pass. So here's the pessimistic scenario. If the flow of crude oil and natural gas is not restored until next year, the IMF expects growth to fall to 2%, a rare occurrence in recent decades.

1:45Inflation would rise to 6%. And that, of course, is a major mismatch, a recipe for trouble. Apart from the countries directly involved in the conflict, energy importers and low-income countries will face the brunt of the pain. So how bad can things get? And what can countries do to protect themselves?

Geetha Gopinath Interview

2:06My guest this week is Geetha Gopinath, an economics professor at Harvard University, who was formerly the chief economist and the first deputy managing director of the IMF. Also, we have one of our regular Ask Me Anything sessions next week, live on the website. I would love to take your questions. So write us at live at foreignpolicy.com or head to our website to leave a question and register for the live discussion on video. So let's dive in.

2:38Geetha, welcome to FP Live. Hi, Ravi. Pleasure to join you. So let's just start with this. The IMF projections I mentioned at the start were from a couple of weeks ago. The Strait of Hormuz is still essentially shut down. There's no real sign of when it properly opens up. What is your sense now of how bad all of this could get for global growth? So, Ravi, what the IMF did very helpfully is provide scenarios because precisely this very

3:10high level of uncertainty around how this conflict is going to evolve. They had this reference scenario, which is what you laid out, where growth drops to about 3.1%, which is about a 0.3 percentage point drop, not that much. You do have inflation going up some more, like about 60 to 80 basis points for the world. The problem, of course, is that that's the best case scenario. And it was in the assumption that this conflict would end relatively quickly, which was a reasonable

3:45assumption, one of the reasonable assumptions one could make. Now, if this continues, and the fact that we are still here with no ships going through the Strait of Hormuz, regardless of the fact that there's no bombs necessarily falling, but the fact that shipping has basically come to a standstill through that strait has much more durable implications than what would be there in the reference scenario. And so the IMF provided what they called an adverse scenario, which is when we are looking

4:17at oil averaging about $100 a barrel for this year, as opposed to the assumption in the reference scenario, which is more like $82 a barrel. So if there's about $100 a barrel and you have some more tightening of financial conditions, then we are looking at a global economy that's going to grow at only 2.5%. Now, it's not common for the world economy to slow that much. And if it gets even worse, and we are looking at oil averaging $110 a barrel this year, and

4:48this is a much more disrupted situation with bigger hits to energy infrastructure, which means next year or two, oil is going to stay very high, and financial conditions get a whole lot worse, then we're looking at the world economy growing at 2%, which again, those are extremely rare occurrences. So the risk seems squarely to the downside at this current point. It's, of course, affecting different countries differentially. The ones that are most hard hit are, of course, the countries right in the conflict, the Middle

5:21East, including countries like Saudi Arabia, which had one of the larger downgrades among the major economies. But the UAE, Qatar, all of these countries are also being impacted in addition to, of course, Iran. And Gita, actually, on that, I have one more chart I want to bring up for those listening on audio. I'll just describe it quickly. This is a chart that shows how energy exporters are largely avoiding the growth slowdown we've been talking about. Energy importers are projected to slow a fair bit, of course, because of higher prices.

5:54But even there, it is not even. Low-income economies are falling the most by far, as much as half a percentage point. And then finally, you have conflict-affected states, which are projected to slow by two percentage points this year. And these are the Gulf countries, of course, including energy exporters. So the impacts are really felt differently depending on where you are geographically, Gita, but also on whether you import or export your energy.

6:25Exactly. And it also depends upon whether you're a beneficiary of the AI wave or not. So if you look at energy importers in Asia, like, say, South Korea, it is one of the countries that's most exposed to the conflict in terms of reliance on the Middle East for their energy. But the effect has been minimal, in a sense, because of the fact that they're also part of the AI cycle. And they've been benefiting through a big increase in exports that are AI-related.

6:57So we have these different trends that are affecting the world economy. And depending upon where you are in that supply chain, you get more or less affected, on average. You were just in India last week. Talk a little bit about how a country like that is facing the economic pressure from the war. I've heard so much about restaurants shutting down, people rationing fuel. And India, of course, to be clear, is in much better fiscal shape than many of its neighbors, which are doing far worse.

7:28So India, among the major economies, India is being affected because of its heavy reliance on the Middle East in terms of imports of oil, also liquefied petroleum gas, which is LPG, which is what goes into cooking purposes. There's also a reliance on the Middle East just as a hub for sending their goods to other parts of the world, also reliance on remittances from the region. So there are multiple channels through which India gets affected.

8:00And I think what we're seeing most directly is the effect that's showing up in terms of pressure on the currency, because the expectation is that as the import bill grows, the current account deficit grows, and in the absence of strong portfolio inflows into India, that's going to put pressure on the rupee. And so I think that's where we're seeing it. As of now, the government has held off passing through price increases to fuel pumps. I don't think that's going to be sustainable for that much longer, because this is requiring

8:34some very high subsidies that the government will have to provide eventually for this to hold up. So at some point, you should expect to see that showing up also in inflation, in headline inflation. As of now, that's not the case. But yes, India is a country that's been affected by this. But again, to my point of the different trends that are hitting countries, one thing that did get better over the last months was the average tariff rate that got imposed on India from the US, which went down from 50% to, you know, the 10% additional number. So it's, that is a positive

9:09tailwind for India. And since you mentioned tariffs, if we were to just zoom out a little bit, what was the state of the economy writ large before this latest energy shock? Because it strikes me that between the COVID-19 pandemic, and then the war in Ukraine, and then you had President Trump's unilateral tariffs on most countries on earth, there were many reasons already for many countries around the world to feel economic stress, whether it's through disrupted energy supplies, disrupted supply chains

9:43more generally, or a sense of unease about global trade, and whether they can, in fact, rely on a free and open trading system. So there were already many stressors on the system, right?

9:58Well, we've seen over the last couple of years, it's certainly been a buildup of big structural shifts that are going on. One, of course, is geoeconomic fragmentation, but the other is on AI, the developments on that front. And the one thing that's been constant, and is quite critical to why we still remain in a world where growth is not heavily impaired, is that financial conditions have been good. Even after all these shocks, we've seen some tightening, slight tightening,

10:30but by any historical standard, these are very good financial conditions that we have. If you look at measures, including the stock market, I mean, the US stock market is back at a record high. Corporate borrowing spreads have gone up some tiny amount, but overall, historical comparisons, this is very favorable financial conditions. And in 2025, because the dollar depreciated, that was also a favorable financial conditions for emerging and developing countries. So what depends critically, frankly,

11:04in terms of what the consequences can be of this current energy crisis and the rest of the world spilling over something much more bigger, depends crucially on whether it gets amplified through a severe tightening of financial conditions. I mean, that is very important. In the absence of a severe tightening of financial conditions, the direct effects of oil and gas prices going up. Obviously, some countries are much harder hit than others, but for the global economy as a whole, that is still quite well contained. Hmm. And I guess it's worth right here just spending a few minutes on how

11:39interconnected everything is here. You know, I learned recently that nylon and polyester come from petroleum products. So the price of thread has doubled in Bangladesh. We know that universities have been shut down in many countries in South and Southeast Asia. The Philippines declared a national energy emergency. Many airlines around the world, but many of them specifically in Asia are cutting flights because jet fuel prices have doubled. What's your sense, Geetha? At what point these blows sort of compound and then start turning into a slowdown, people just consuming less? And then at what point

12:16do we start worrying about a recession? So again, you're right that we have much more than just talking about oil and gas. There are many of the products that oil and gas produce that are being affected by it. You're also seeing an effect on sulfur. You know, fertilizer prices have gone up by a lot, and that's going to have an effect on food prices. Six months down the line, it doesn't happen right now. The price of NAFTA has gone up. So, you know, helium, which is again a byproduct of LNG production,

12:50all of that is affecting the supply of it has been affected in the world market. The expectation as of now is that, again, that there will be a relatively quick end to this whole situation without much bigger damage in any permanent basis to energy facilities. And therefore, that we may not have a big effect. What we could see is some slowing down, which is what the IMF has in its reference forecast, which is what you see. Some countries more than other. Obviously, low-income

13:21countries that are much more dependent on, you know, the fact that if energy prices go up and as food prices go up, the negative impact on them is much bigger than for other markets. So low-income countries, unfortunately, get affected much more by this. But for most other major large economies in the world, you know, these effects are meaningful, but it's not at this current juncture. It's not something that we can see this in and of itself pushing the world into any kind of recession, which,

13:52by the way, when we talk about recession for the world economy, we're talking about growth going under 2%. I mean, it's extremely rare to get to growth of negative numbers. The last time we had growth being a negative number for the world economy, that was during the pandemic, the one year in 2020. During the great financial crisis, global growth was basically, you know, 0% at that time. That's great context. If the Strait of Hormuz remains shut for another month, two months,

14:22what is your sense of the countries that we should be most worried about, especially poor countries that have limited fiscal room, that are already struggling with a strong dollar, that import their energy needs and other products? What should we be looking out for? Well, I mean, right away now, I would be looking at the countries that have programs with the IMF that are energy importers. Take the example of Sri Lanka. Sri Lanka was a country that went through a very bad crisis, was on the path of recovery. This kind of a shock is like a nightmare situation for

14:57a country like that, which is just trying to get out of the crisis that it had with fuel prices the way it is with fertilizer prices going up. More generally, with jet fuel prices going up, which means travel is going to become much more expensive, which means tourism is affected in the region. Countries like that, Pakistan is another country that is in a fragile situation with everything that's going on. These are the countries where you would see the effect showing up. Nigeria is being impacted also

15:28by it. So countries that have some fragility in their system and have a program with the IMF are the ones that you would expect to see really deep distress in these countries. In other parts of the world, you're going to have some more inflation than even what's being projected at this time. That can be very painful. Cost of living goes up and we already know there's a bit of a cost of living, huge affordability problem in many countries of the world, including in the US.

16:01And as inflation goes up and you don't have the income to pay for basic necessities, you're going to cut back on consumption and that should then affect growth further. So now we're getting to the scenario where you really have growth now going down to two and a half percent. Not a common phenomenon for the world economy. Keita, what should countries like, say, Sri Lanka, what should they be doing to become more resilient in the face of these shocks? I mean, it's very clear to me that we are in an era now of immense

16:34geopolitical risk. Whatever happens with this Iran conflict, in my mind, this is not the last such conflict we're going to see in the coming years. So what is the recommendation for countries to become more resilient? And also, you know, were we too reliant on globalization and on the proliferation of cheap goods through that?

16:58I think energy independence is going to be critical. And thankfully, for many countries in the world, there are alternatives. I mean, there are renewables that one can invest and develop even more. I mean, Sri Lanka with, you know, solar can do great. So energy independence, I think, is very doable for countries. The cost of doing it in terms of just inputs that are required is cheaper, much cheaper than it used to be. You need to make sure that your grids are updated and that they can actually get the

17:31energy from through these renewables. So there's work to be done there and investment to be done there. But I would say that that just seems like something of a no-brainer in terms of developing alternative sources of energy at home and renewables are a great source for that. Into your general question of what we're seeing in terms of the world and geoeconomic fragmentation and that have we now moved away from the paradigm where you could rely on trading partners for

18:02goods that you needed. On the glass half full version of it, I think it's helpful to note that still about 70 plus percent of global trade is conducted under the rules of the World Trade Organization. And I think this is an important difference between now and the 1920s when you had tit-for-tat tariffs and every country went into isolation, basically, and you had the Great Depression. This time around, you haven't seen very big rounds of tit-for-tat tariffs. It's basically

18:36been the US and then China has responded, but most other countries haven't. And I think it's because of the recognition that there are lots of benefits from global trade. And we'll be back in a minute with more of Foreign Policy Live. Remember, you can catch these conversations live and on video on foreignpolicy.com. Subscribers get to send us questions in advance in addition to a range of other benefits, including our magazine. Sign up.

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Countries Emerging Better

19:43You know, we've been talking a lot about countries that are suffering from the current energy shock. I want to talk about a few countries that could be seen as suffering less or maybe even emerging as winners. And one of the interesting countries to look at is actually the United States. It's now the world's undisputed energy superpower, biggest crude producer, biggest natural gas producer. As you've mentioned as well, it's an AI superpower, which means that, you know, the stock market has been on a tear. And in a sense, some of that feels almost decoupled from the rest of the world.

20:18Talk a little bit about the advantages America has right now. And, you know, just if you can put that in historic terms, how unusual is it for there to be so many profound geopolitical shocks, two wars going on, COVID, of course, and yet the United States is emerging, not only resilient, but with all of these cards to play. The U.S. is doing incredibly well because of where it is in the AI race. I mean, it is at the front.

20:52China is also up there pretty close. Outside of these two countries, there are not many other regions of the world that have this much dynamism when it comes to AI. And if you look at 2025 and growth in 2025, basically AI, you know, offset the drag that came from tariffs, right? Almost one-to-one. So that was the positive effect that came from AI. And what's interesting is you see that despite everything that's happened over the last, you know, 24 months or so, the U.S. remains the part

21:28of the world where people want to hold equities. So if you look at the net capital inflows into the U.S. in 2025, that was at a record high. And especially the desire to hold U.S. equities is at a record high. And so while we did see some rotation out in 2025 to other regions, including to emerging markets, when it came to emerging markets especially, most of that rotation was mostly in the form of bond flows, right? So buying debt as opposed to equities or foreign direct

22:02investment. And so we are in this world where we have unbalanced growth. The U.S. is seen as the country where productivity growth is high. So productivity levels are rising. There's AI dynamism. There's deregulation. There's a sense of a lot more growth opportunities in the U.S. And then if you look at the rest of the world, it seems like there is much less of that happening. And so because of this unbalanced growth dynamics, we have basically the world's savings resting on fairly narrow

22:37foundations. Unless we see much more of growth dynamism in other parts of the world, including in Europe, including in emerging and developing countries having a good story of reform, fiscal prudence, and so on, we are going to see this imbalance in the world. How worried are you that we might be in an AI bubble? There are lots of reasons to think we might be in an AI bubble. For one, the simple reason, again, now we're back to U.S. stock markets being driven by basically the AI stocks. I mean,

23:14those are the ones that are leading the run-up in stock valuations recently. There was some correction towards the end of last year and the start of this year, but that has happened. You've seen software stocks or you've seen AI tech stocks booming again. And the question that always comes is that with any technology that is transforming and evolving, we are certainly not clear at all, which is the technology that we're all going to be using in five years, right? There's always a new

23:45product on the market. There are new companies coming up and putting products out. And so the risk is that the current incumbents have invested a large amount in their AI infrastructure, in data centers, in trillions of dollars, in the hope that they will be able to raise revenues that can explain, justify this level of investments that they're making. And that is completely unclear because you could very easily have another competitor come in and produce the same product or pretty close to

24:16the same product, a fraction of the cost, given how the technology is evolving. And then the current incumbents can't really make the money they're expected to make to justify their investments. And that's not just true about the services companies in terms of AI products and LLMs and so on, but it's also true of the chips that are going in, whether it's going to be the GPUs or the TPUs, which are the ones that are going to ultimately survive, how obsolete are one kind of chips going to get. It's just a fast, rapidly changing technology. And we still don't have a very clear

24:48sense of why some companies will be clear winners in this race and be able to get enough of market share and therefore extract enough profits to justify the levels of investments that they're making. So that's a sense in which this feels like a bubble, but it doesn't necessarily mean that this bursts tomorrow. That's the hardest part, is predicting when you might have a correction. Yeah, that's well put. We were looking at countries that seem to be emerging better off from the current crisis in the Middle East. And I meant to bring up Russia. Russia now is navigating not one, but two wars.

25:25And this most recent crisis has given it a daily windfall in the order of hundreds of millions of dollars from the higher price of crude. What is your sense of the longer term trajectory now of Russia's economy? Because it seems to have, on the one hand, turned itself into a war machine, a wartime economy that is able to still grow despite the adverse effects of war. And yet the flip side of that is that it's extremely dependent on war, and that when those wars end or circumstances change,

26:00it might not emerge from it so well. The war was already, the war that Russia was waging against Ukraine was already taking a toll on Russia before this conflict came about. So actually, in the absence of this conflict, they would have been in much worse place. Because of what's happened with the oil prices going up, and the fact that countries are being allowed to go and buy from Russia, they're back on the market, they're making, as you said, all these windfall profits from it. So I think that that is

26:31helping them. But as the longer story goes, Russia made some bad choices. Its decision to invade Ukraine has been tremendously costly. It has led to an allocation of resources to this war economy. And that's affected their productivity, that's affected their more critical investments that they need to make. And it's also affected the number of people who are staying in Russia and willing to walk and contribute to the country, right? I mean, there's been this exodus of people

27:01out of Russia. So for all those reasons, you know, this is not going to end well. You know, the true line in our entire conversation today, Geetha, has basically been a world of conflict, and how countries are navigating that. And obviously, energy exporters have a leg up, countries that are highly dependent on the interconnectedness of the global system suffer the most. And then the poorest countries, the least developed countries, are the ones with the least fiscal room to manage and navigate some of the pain that emerges. When the dust settles in the next few

New Global Compact

27:37years, what kind of new compact are you expecting to emerge? I mean, if you are a smaller country, and frankly, that is most countries on earth, you know, what are the things you need to look to put in place to be able to sustain a more turbulent global ecosystem? We certainly have to prepare ourselves for a much more volatile world than we've been used to. I don't know if you saw the headlines today that the UAE have decided to pull out of OPEC. That's just another contributor to

28:14volatility. I mean, on the plus side, you could see that it may prevent having a high price floor on oil. But one of the things that OPEC did was prevent a large amount of volatility in these prices. And if the UAE pulls out, you could have a lot more volatility. So another contributor to volatility more generally in the world economy. What countries can and cannot do, firstly, it's going to depend a lot on the country itself. So if you're a large economy, you have a large domestic market,

28:44the US is one of those. India is also there. Europe, if they can especially build their single market. These are countries that I think are going to do a lot more at home too, in terms of especially critical things like energy independence. But also, you know, if you have to do semiconductors or rare earths and so on, not ideal, especially for emerging markets to do, given that there are finite resources. But I just expect there's going to be a build out of defense in many of these countries. Defense spending is going to go up. National security spending is going to go up.

29:18So that will happen. For many other countries that are small and cannot really rely on their internal market, they're going to have to maintain diversified relations with many countries. They're going to work with many others. I think, again, something I said earlier, which is on the positive side, there is a big chunk of trade and a large number of countries that are very keen on preserving a rules-based global order because they've benefited from it. And therefore, you know, with rare exception, I think most countries actually want to continue to be able to work together in a way

29:53that's predictable, that gives their businesses and companies and their households certainty and predictability. So that desire still exists. I'm very curious to see how the rounds of the G7 and the G20 end this year. I mean, the G7 is with France and the G20 is with the US. And so I'm curious to see how that conversation ends at the Leaders Summit, for instance, to see about what may be the direction in which the world travels. You and me both, and we'll have to stick around to see what

30:23happens there. Geeta Gopinath, thanks so much for making time for us. Thank you, Ravi. And that was Geeta Gopinath, a Harvard economist who was formerly Chief Economist at the IMF. Lots more coming up on FP Live next week. And ask me anything. You can send your questions on our website, foreignpolicy.com slash live, or email us directly. That is live at foreignpolicy.com. FP Live, the podcast is produced by Rosie Julin. The executive producer of the show is Donna

30:58Schoen. And I'm Ravi Agrawal. I'll see you next time.