The Red Sea crisis and its impact on the global economy

In the past few months, several regional and global developments, such as the war in Gaza and the Houthi attacks in the Red Sea, have changed the geopolitical climate of the Middle East. After the disengagement of the US and the subsequent entry of China into the Middle East region, followed by the Saudi-Iran rapprochement in March 2023, Middle East analysts had hoped that the region had embarked upon the peace-achieving journey with an optimistic result for the global economy. However, everything aside, one issue that has been constantly on the back burner of most regional leaders has been the Palestinian struggle, which is leaving its effects on the regional chessboard of the Middle East. One such example is the disruption in the global supply chain via the Red Sea.

Following the Abraham Accords in 2020, former US President Donald Trump claimed that the historic normalisation between Israel and Arab states would end “decades of division and conflict”. However, the current situation in Gaza and the wider Middle East suggests otherwise. The ignorant presumption has partially triggered the Hamas-Israel conflict, followed by inhumane atrocities by the Israel Defense Forces (IDF), which have so far killed over 30,000 innocent Palestinians, primarily children and women, as of 9 March 2024. Apart from the history and nature of the conflict, the current situation holds a potential challenge vis-a-vis its regional expansion. In this regard, the latent indicators are becoming visible in Southern Lebanon and the Red Sea.

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On 2 January, 2024, an alleged Israel-backed drone attack in Beirut, Lebanon, killed Hamas senior official Saleh Al-Arouri. Similarly, in the Red Sea, the US announced a naval coalition of 20 countries to safeguard the sea’s waters on 19 December, 2023. The announcement came in response to the Yemen-based Houthi attacks on Israel-bound cargo ships in a bid to show solidarity with Palestinians and push Israel’s Western allies to press Tel Aviv to end atrocities against Palestinians. Following the incident, Iran sent its Alborz warship into the Red Sea via the strategic Bab El-Mandeb strait to allegedly conduct anti-piracy and shipping route-safety tasks in open waters, which its vessels have been performing since 2009. Iran’s naval presence in the Red Sea has boosted the confidence of Houthis as they have not backed down from their actions. Instead, they have designated the US and the UK as “terrorist states”, thus adding another layer to the already complex regional situation.

The Red Sea connects Bab El-Mandeb in the Gulf of Aden with the Suez Canal and manages almost one-third of the global container cargo ships. Bab El-Mandeb lies between Africa and the Arabian Peninsula, via which nearly 13 per cent of the international trade by volume takes place and nearly 30 per cent of the globe’s container traffic passes. However, following the outbreak of the conflict, the degree of global sea traffic from the Red Sea has dropped, with a decline of 1.3 per cent in global trade in December 2023.

This significant descent in the flow of sea traffic has forced the container giants to suspend or reroute their shipping lines and sail around South Africa’s Cape of Good Hope – a relatively longer, more expensive and time-consuming trade route. Seven of the top ten shipping companies have suspended the Red Sea route for their transportation activities, including the Chinese state-owned COSCO – the fourth largest shipping company contributing 11 per cent to global trade.

More than the developing situation in the Red Sea, the timing of the conflict is alarming. At this time, the Panama Canal – an 82-kilometre-long manufactured water body connecting the Atlantic Ocean with the Pacific Ocean – is facing extreme drought and, therefore, limiting the options for trading companies to undertake. Similarly, citing the rising threat of attacks on the commerce vessels, various marine insurance companies have expanded the section of riskiest waters in the Red Sea, increasing the war-risk insurance for shipments by ten times from 0.7 per cent of a ship’s value to 1 per cent. Furthermore, there does not seem to be any indication of de-escalation in the region at this point, thus keeping the flow of sea traffic diverted for an unforeseeable future. Earlier, Maersk, the second-largest ocean goods carrier, feared that diversion from the Red Sea route could extend into the second half of 2024.

Unfortunately, the situation could contribute to global inflation – mainly in the energy sector – unprecedentedly affecting local consumers – primarily Europeans. Nearly 40 per cent of the trade between Asia and Europe occurs through the Red Sea, with almost 12 per cent of oil and 8 per cent of liquified natural gas (LNG) passing through the Suez Canal. Since the US-led attacks on the Houthis, crude prices have risen by 4 per cent, followed by an increase in the transporting rates of a container ship from $1,500 to $4,000 – specifically due to an additional 6,500-kilometre distance and an extra $1 million fuel cost. Even though the container rates are not so close to the ones during COVID-19, i.e. $14,000, the threats of the conflict’s regional reverberation can materialise this surge. This could increase the prices of domestic-usage products in Europe, which are already expensive given the Russia-Ukraine war and subsequent sanctions on Moscow.

Similarly, many US and European companies have halted their operations, citing disruption in the global supply chain. Earlier, Tesla – a multinational automotive company – temporarily halted manufacturing its Model-Y vehicles in Grünheide, Germany, from 29 January to 11 February, due to the unavailability of manufacturing parts. However, the production was resumed afterwards on the due date as the supply chains became “intact”.

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Apart from posing a hindrance to the smooth flow of sea traffic from the Red Sea, the situation is also reversing the efforts made in the last few years to deal with the humanitarian crisis emanating from Yemen due to the ten-year civil war. On 18 January, 2024, the US redesigned the Houthis as a “Specially Designated Global Terrorist Group” (SDGT) – nearly three years after removing the group from the same designated category to enable humanitarian assistance in Yemen. The move comes at a time when Yemen is going through one of the worst humanitarian crises in the region, with nearly 21.6 million people – over half of the total population – in need of humanitarian assistance. Seemingly, instead of pressing the Houthis on their actions, the US move would worsen the situation in Yemen as the designation would create hurdles for the inflow of humanitarian assistance into the country. Earlier, citing the evolving situation, Yemen’s Ministry of Foreign Affairs in Sanaa warned the US and UK citizens working in the United Nations aid and humanitarian agencies to evacuate the country.

Nevertheless, for the railway sector of Asia and Europe, the situation in the Red Sea is an opportunity to revive the rail routes, especially Russian, that were abandoned due to Western sanctions on Moscow. Earlier, German DHL, a logistics and shipping company, witnessed a significant 40 per cent increase in demand for Russian railroad services. Similarly, RailGate Europe noted a 25 to 35 per cent rise in transportation demands, as it takes only 14 to 25 days to ship cargo from China to different parts of Europe.

The complex geopolitical dynamics in the Middle East underscore the fragility of regional stability and its far-reaching implications for the global economy. The imperative for international cooperation and concerted diplomatic efforts to de-escalate tensions, facilitate humanitarian assistance and promote stability cannot be overstated in this volatile landscape. Only through sustained dialogue, constructive engagement and multilateral cooperation can the region move towards a more peaceful and prosperous future that benefits not only the countries of the Middle East but the global community as a whole.

The views expressed in this article belong to the author and do not necessarily reflect the editorial policy of Middle East Monitor.