In April 2026, the International Monetary Fund took the unusual step of issuing a ‘reference forecast’ that assumed the disruptions caused by the Gulf war would fade by mid-2026. It added “adverse” and “severe” scenarios reflecting the heightened uncertainty and several other issues confronting the global economy.
The immediate concern is inflation. The closure of the Hormuz Strait and attacks on energy facilities in Gulf Cooperation Council countries allied to the US has reduced global oil and gas supply by around 12 percent and 20 percent. It is the largest interruption in energy supplies in history, greater than the impact of the 1979 Iranian revolution, the 1973 Arab oil embargo, Saddam Hussein’s 1990 invasion of Kuwait, or the Iran-Iraq war in the 1980s.
Higher energy prices feed inflation. Global energy intensity has fallen from 131 litres per $1,000 of GDP at 2025 prices in 1973 and 116 litres in 1980 to 52 litres today. While this means that the average oil burden is 60 percent lower than 50 years ago, the needs are now concentrated in critical areas without easy substitutes, like freight transport, which are less price-sensitive and non-discretionary. The full impact of higher prices on essentials will only emerge slowly as higher energy prices and shortages of petroleum derivatives, such as fertiliser and other chemicals, bleed into the economy. With the full restoration of energy and other material supplies likely to take some time after the end of hostilities, supply chains may remain constrained and prices elevated for an extended period. Higher inflation means higher rates for longer, particularly for longer maturities.
The second worry is growth. Outside of the US where manic AI investment, tax cuts and government spending is driving expansion, economic activity is stalling. In most countries, higher prices, doubt and volatility is sapping confidence. Consumption and investment are slowing. In the US, households in the bottom third by income distribution are now consuming 7 percent less, although spending by the top third remains unaffected. This K-shaped economy, where different socio-economic groups diverge, is unsustainable.
The impact will be greatest for energy importers and countries with existing fragilities, such as economies with narrowly bases, low incomes, or high debt levels. Europe, already facing challenges before the Gulf war, faces major headwinds. But Asia and Africa are likely to be the worst affected. Lower income groups are particularly vulnerable. High fuel and fertiliser costs will impact farmers, many of them living at subsistence levels. Rising diesel costs have already crippled many industries. Small street vendors will struggle to continue because of higher cooking gas and plastic container prices. Countries dependent on tourism are seeing sharp drops in bookings reminiscent of the Covid pandemic as disposable incomes drops and airfares rise.
The spectre of stagflation, low growth and high inflation, reminiscent of the 1970s also after oil shocks, hangs over the global economy. If the Iran war continues or escalates, then a worldwide recession or even depression cannot be discounted.
The damage to public finances is substantial. The military cost of the Iran “excursion” for the US alone may already be over $70 billion, though the official count is a fraction. The administration is seeking to boost defence spending by 44 percent to $1.5 trillion. The total economic costs, including costs of repairing infrastructure and human damage, interest on debt, and impact on the economy, may exceed $1 trillion. The Iraq war’s total cost is now estimated at $2 trillion or more.
Subsidies or other measures to ease cost of living pressures add to government spending. Further deterioration in economic conditions will reduce tax revenues and increase welfare spending, accelerating deficits. This expenditure must be financed and will increase pressure on rates and may squeeze our other borrowers.
The combination of factors risks setting off a financial crisis. Higher rates, slow growth and concerns about government debt, already present, could trigger synchronised sell-offs across overvalued public stocks and bond markets. The threat is even greater in opaque private markets which are inherently illiquid and lack transparency.
The longer-term risk is deflation. In economics, the answer to higher prices is even higher prices. The resultant demand destruction, often long lasting, ultimately drives price lower as consumption collapses. In combination with the impact on supply and costs of Chinese industrial overcapacity and AI, the risk of falling prices is far from trivial.
Deflation would be destructive especially for indebted economies. Stagnating or falling incomes and tax revenues combined with deferred consumption and investment in anticipation of lower future prices would make meeting debt payments difficult. Real debt levels would increase—intensifying the problem. It would drive declines in asset prices which support borrowings triggering banking crises. The world has experienced debt deflation in the 1930s Great Depression, Japan’s lost decades, and the aftermath of the European debt crisis in Southern Europe creating enormous financial and social hardship.
The problems are compounded by constraints on the ability of governments to take corrective measures. Many states have high levels of debt. Higher interest rates and rising interest expenses would magnify the limits. Cutting rates is difficult amidst inflationary pressures. Many central banks have bloated balance sheets in the wake of multiple rounds of quantitative easing. Money market conditions are already loose.
Policy makers may have to expand their options. This could include income and price controls. Nationalisation of certain industries to control supply chains and prices is another possibility. Financial repression, where domestic investors are forced to finance governments through the purchase of bonds issued at negative real rates, is another alternative. Explicit controls and taxes on exports and imports or financial transactions are possible. Institutional changes, such as co-operation between governments and central banks to finance spending and control currencies, may be considered. But to resort to these processes together with the realisation that the official backstop to asset prices is weak or absent could itself trigger or accelerate economic and financial instability.
Interestingly, businesses and investors seem to be oblivious to these risks. This optimism, ignorance or cognitive dissonance may turn out to be misplaced. Shakespeare noted, “Desperate times breed desperate measures”; but it may also breed desperate hope.
Satyajit Das | Former banker and author of A Banquet of Consequences
(Views are personal)