Governments worldwide are confronting heightened pressure on already strained public finances as the prolonged conflict in the Middle East persists.
Officials from London to Seoul to Bangkok face a difficult dilemma: increase fiscal spending to shield citizens from rising energy costs, risking the ire of global bond investors, or maintain fiscal discipline and face the near-certain political backlash that would follow.
"Fiscal space matters, but the more significant driver here is actually political pressure," stated Angel Talavera, Chief European Economist at Oxford Economics. "With energy prices becoming a highly sensitive issue for voters, the threshold for government action has significantly lowered."
To date, fiscal interventions have remained relatively limited, primarily focused on reducing fuel costs for drivers. This targeted support is still manageable.
However, as Iran strikes major energy facilities in Qatar and Saudi Arabia in retaliation for an airstrike on its South Pars offshore gas field, signs of disruption to global energy flows show no sign of abating. Officials may soon be forced to make tough choices between alleviating economic pain and cutting budgets for popular public programs, potentially leading to increased borrowing.
Europe: Capacity Exists, but at a Painful Cost Approximately 20% of the world's oil and liquefied natural gas transits the Strait of Hormuz, with about 80% destined for Asian markets. Some Asian airlines fear imminent jet fuel shortages; the government of Bangladesh has ordered fuel rationing and closed universities; and several local governments in the Philippines have shifted to a four-day workweek.
Although European nations import relatively less oil and gas directly from the Middle East, energy prices have still surged significantly. Analysts warn that European buyers will have to compete fiercely with Asian importers for supplies from other regions, further driving up prices.
Sander Tordoir, Chief Economist at the Centre for European Reform, noted that overall public finances in Europe remain in decent shape, but the outlook would be concerning if it required a repeat of the massive subsidies provided to consumers and businesses in 2022.
In 2022, energy subsidies in the EU nearly doubled from the previous year to €397 billion. Over two years, the UK government provided around £75 billion in support, including subsidies for household energy bills.
"If European countries need to spend on this order of magnitude again, they can do it, but it will be very painful," Tordoir said.
The UK may be the starkest example. This week, the government announced £53 million in funding to assist households reliant on heating oil, a particular issue in Northern Ireland. However, it has refrained from broader measures, such as delaying an upcoming increase in fuel duty for vehicles.
The UK government is currently adhering strictly to fiscal rules to reassure bond investors concerned about high debt and low growth prospects. UK government bond yields often rise faster than those of neighboring countries during market sell-offs, pushing up borrowing costs. Last year, one pound in every ten of UK government spending went towards debt interest payments. Just as fiscal conditions were beginning to improve, the Iran conflict threatens to disrupt this trend.
"The UK is particularly vulnerable," Tordoir stated.
Marcel Fratzscher, President of the German Institute for Economic Research, indicated that Germany, as Europe's largest economy, has little fiscal wiggle room. In 2022, Germany temporarily reduced taxes on gasoline and diesel, a measure that alone cost €3 billion.
His institute estimates that if oil and gas prices remain at current levels for the rest of the year, Germany's economic growth rate for this year could be halved to 0.5%.
"This isn't something the government can finance from the existing budget or solve with simple reallocations," he said, "and this is just the beginning."
The situation is similar in France. Although its heavy reliance on nuclear power provides a more stable energy structure, the government has long struggled to reduce its debt level. Talavera pointed out that France is "a country that cannot afford large-scale additional spending."
Greece, Spain, and Portugal represent relative bright spots. Once sources of concern due to high debt and weak fiscal discipline, their fiscal positions have improved: some have reduced debt, while others, like Spain, have gained buffers through strong economic growth. This allows them to be among the first to implement measures protecting households and businesses from rising costs.
Asia: A Fresh Oil Shock Asia has been working in recent years to compress fiscal deficits that ballooned during the pandemic. However, trade disruptions caused by the war represent "another shock" that could push debt higher again, according to Albert Park, Chief Economist at the Asian Development Bank.
Wealthier economies like Japan and South Korea already have measures such as energy vouchers to help consumers cope with price increases, alongside ample foreign exchange reserves and access to financing.
In contrast, the impact on emerging markets in Asia is expected to be more pronounced. Stefan Angrick, Senior Economist for Japan and Frontier Asia at Moody's Analytics, noted that governments, particularly in Southeast Asia, have historically used fiscal subsidies to cushion energy price volatility, a strategy widely employed in 2022.
At that time, Thailand utilized its state oil fund to subsidize prices. By mid-2022, the fund had accumulated a deficit of several billion dollars, forcing the government to provide emergency loan guarantees.
Thailand is again relying on this fund, injecting tens of millions of dollars daily to subsidize diesel. This month, the fund fell into deficit again, and the government is considering new loan guarantees.
Nomura recently warned that both Thailand and Indonesia face risks of sovereign credit rating downgrades. The Indonesian government has also signaled plans to increase fuel subsidies, which could raise borrowing costs.
Current fiscal interventions in these countries "will help to curb volatility, but cannot be sustained indefinitely given fiscal constraints," Angrick stated.
Among the most vulnerable nations in Asia, Bangladesh and Pakistan stand out, as they rely on the Middle East for over two-thirds of their LNG and oil supplies and are already under financing pressure.
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