Guan Tao: Confront Middle East risk spillover directly, stabilize China's economic fundamentals

As the duration of the conflict continues to lengthen and the scope of its impact expands, the risk of a sharp rise in energy prices remains high, which will genuinely test the resilience of global economic growth.

Since February 28, as the United States and Israel have jointly launched military action against Iran, tensions in the Middle East have intensified. So far, the U.S.-Israel-Iran conflict has caused substantial disruptions to global financial and energy markets, but its impact on China has been relatively limited. As the conflict continues to last longer and its impact expands, the risk of a significant rise in energy prices remains high, which will genuinely test the resilience of global economic growth. At the same time, external risks may deliver negative shocks to China’s economy through multiple channels.

The Middle East situation has had a limited impact on China so far

Since the U.S.-Israel-Iran conflict erupted in late February, market risk-aversion sentiment has risen significantly, and volatility in global financial markets has increased.

Global stock markets are broadly under pressure and show clear divergence. From March 2 to April 3, the MSCI Emerging Markets Index fell cumulatively by 8.4%, which is greater than the 4.7% drop in the MSCI Developed Markets Index. In the same period, major stock indices in Asia and Europe performed relatively worse. Korea’s Composite Index, the Nikkei 225, Germany’s DAX, and France’s CAC 40 fell cumulatively by 13.9%, 9.7%, 8.6%, and 7.2%, respectively—exceeding the S&P 500’s decline of 4.3%. By comparison, China’s A-shares have been relatively stable, with the Shanghai Composite Index falling cumulatively by 6.8%.

Government bond yields in major economies have generally moved higher. From March 2 to April 3, the UK 10-year government bond yield rose by 54 basis points. U.S. Treasuries—also a traditional safe-haven asset—were sold off as well. The U.S. 10-year government bond yield rose by 34 basis points to 4.31%, and at one point climbed to 4.44%, the highest level since late July 2025. Germany’s and Japan’s 10-year government bond yields rose by 34 and 27 basis points, respectively. China’s 10-year government bond yield only edged up by 4 basis points, and overall volatility remained low.

The U.S. dollar index rebounded, while most non-U.S. currencies fell. From March 2 to April 3, the U.S. dollar index rose from 97.6 to 100.2, increasing cumulatively by 2.6%. In the same period, the Swiss franc, euro, yen, and British pound against the U.S. dollar fell by 3.9%, 2.5%, 2.2%, and 2.1%, respectively, while China’s renminbi exchange rate reference rate appreciated by 0.4%. The trading prices of the renminbi both onshore and offshore fell by less than 0.5%, and the Wind Renminbi Exchange Rate Forecast Index rose by 2.2%.

China’s relative resilience in financial markets is mainly due to the asymmetric shock from the Middle East tensions. Although China is a major energy-consuming country, the share of oil and gas consumption is relatively low, and China’s dependence on oil and gas imports—and on Middle East oil and gas in particular—is far lower than that of economies such as South Korea. In 2024, oil and gas consumption in China accounted for 27% of total energy consumption, while coal, primary electricity, and other energy consumption accounted for 53.2% and 19.8%, respectively. Over the same period, the total scale of China’s oil and gas imports and the share of oil and gas imports from the Middle East in GDP were 2.1% and 0.8%, respectively. By contrast, South Korea, South Africa, India, and Japan had oil and gas import scales as shares of GDP of 7%, 4.9%, 4.2%, and 3%, respectively; and the shares of oil and gas imports from the Middle East in GDP were 4.1%, 2%, 2.1%, and 1.7%, respectively.

The risk of a sharp rise in energy prices remains high

There is significant uncertainty in both the duration and the scope of the U.S.-Israel-Iran conflict. According to predictions from Goldman Sachs and UBS Securities, based on different possible evolution paths of the conflict, the outlook for Brent crude oil prices (the same applies below) has generally been set with a baseline, a downside, and an extreme scenario. However, under any scenario, prices will rise noticeably compared with 2025 (average $69 per barrel).

Baseline scenario: under the assumption of an extended disruption period (assuming the flow through the Strait of Hormuz will be maintained at only 5% of normal levels for up to six weeks) and the logic of global energy security being reshaped (production and idle capacity in the Middle East are highly concentrated, energy infrastructure is fragile, leading to a “security premium” for higher future strategic reserve replenishment and higher forward prices), the oil price could peak at $110–$120 per barrel, with the annual price center of gravity around $85 per barrel.

Downside scenario: under the assumption of a two-month transportation disruption (Strait of Hormuz transport flow will only be fully restored by May) and that Middle East supply gradually recovers after the strait reopens, the oil price could peak at $130–$140 per barrel, with the annual price center of gravity around $100 per barrel.

Extreme scenario: under the assumption that the transportation disruption continues (the conflict in the Middle East remains unresolved by the end of the third quarter, and major oil and gas infrastructure faces further damage risk) and that Middle East production capacity suffers a sustained loss of 2 million barrels per day, the oil price could peak at $150–$160 per barrel, with the annual price center of gravity around $130 per barrel.

As the U.S.-Israel-Iran conflict escalates and lasts longer, the aforementioned risk factors clearly tilt toward more unfavorable scenarios. Recently, IEA (International Energy Agency) Executive Director Fatih Birol said that the disruption in this round of supply is equivalent to the total of two oil crises in the 1970s plus the natural gas crisis triggered by the 2022 Russia-Ukraine conflict. A Goldman Sachs research report further revealed that, given that both sides mutually destroy each other’s energy infrastructure during the military conflict, even if the ceasefire ends, repairing these facilities would still take months or even years. This means that oil production capacity recovery in the Middle East will be slow, and high oil prices may not fall quickly once the conflict eases.

Rising energy prices test the resilience of the global economy

Inflation threats have caused expectations for monetary easing to fade. In the third week of the U.S.-Israel-Iran conflict (March 16 to 20), the Federal Reserve, the European Central Bank, the Bank of England, and the Bank of Japan all stood pat, reaching an hawkish consensus on their monetary policy stances. In the market, the focus on the Federal Reserve has shifted from “when will it cut rates” to “whether it can cut rates.” Debates about the ECB and the Bank of England have moved from focusing on “whether to raise rates” to examining “the speed of rate hikes,” while the Bank of Japan continues to focus on “when to restart rate hikes.” The CME FedWatch tool shows that as of April 2, the market assigns a relatively high probability that the Federal Reserve will not cut rates in 2026.

The global economic outlook faces downside risks. Escalation of the U.S.-Israel-Iran conflict has increased uncertainty significantly, severely disrupting global financial and energy markets and further intensifying downward pressure on the economy. On March 26, the OECD released its first economic outlook report since the outbreak of the U.S.-Israel-Iran conflict. Based on the technical assumption that energy market turmoil will gradually ease and that oil, natural gas, and fertilizer prices will gradually decline starting in mid-2026, the OECD expects global economic growth in 2026 to fall from 3.3% in 2025 to 2.9%. According to the OECD forecast, in a scenario where oil and gas prices are far above the baseline forecast (oil prices rising by about 25% in the first year, and then staying at a high level thereafter) combined with a tightening global financial environment, global economic growth would be 0.3 and 0.5 percentage points lower than the baseline forecast in the first and second years, respectively, and inflation rates would rise by 0.7 and 0.9 percentage points, respectively.

Watch out for risks in the stock and private credit markets for contagion. Before the outbreak of the U.S.-Israel-Iran conflict, debates in the market over whether the AI bubble is about to burst had been ongoing. AI development creates strong demand for energy consumption. The OECD warned that prolonged energy supply and growth disruptions, AI investment returns falling below expectations, and continuously increasing losses in private capital markets could trigger a broader repricing of risks in financial markets, which would then adversely affect private demand. Meanwhile, in recent years, the share of U.S. AI companies in stock and corporate bond issuance has continued to rise. These companies—and related industries—are increasingly financing through private debt and equity markets with lower transparency. This could lead to a high degree of correlation in defaults across multiple credit products. Recently, several large private credit funds experienced redemptions and net cash outflows, which have already shown signs of potential liquidity pressure. Such pressure could transmit to banks by increasing the utilization rate of credit lines, raising concerns about financial stability.

Closely watch the negative spillover effects of external risks

Impact on China’s external demand environment stabilizes. On March 19, the WTO released its latest report noting that, under a baseline scenario that does not consider energy price shocks, it forecasts global commodity trade growth to fall from 4.6% in 2025 to 1.9% in 2026. If oil and gas prices remain at high levels throughout 2026, the trade growth forecast would be revised down by 0.5 percentage points to 1.4%. However, this may underestimate the impact of the U.S.-Israel-Iran conflict on China’s exports. In recent years, China’s export markets have made positive progress in diversification. While its share of exports to the U.S. has declined, exports to Asia and Europe have increased (together accounting for more than 70% in 2025). The distribution of shocks caused by the U.S.-Israel-Iran conflict is not balanced. Asia and Europe—economies with relatively higher dependence on Middle East energy—are hit first. The WTO predicts that under a scenario in which energy prices remain persistently high, Europe and Asia’s import growth rates in 2026 would fall from 2.1% and 6% last year to 0.3% and 2.6%, respectively. Compared with the baseline forecast that does not consider energy price shocks, the import growth forecasts for these two regions are revised down by 1 and 0.7 percentage points, respectively. Some institutions, referencing experience during the pandemic, argue that under high oil price shocks, supply chain reshuffling may lead orders to shift toward China. But unlike during the pandemic, the high oil price shock triggered by the U.S.-Israel-Iran conflict has a global nature, meaning China may be hard to insulate itself. It is expected that the order-shifting effect will be limited in boosting China’s exports, and China’s share of exports may continue to fluctuate within the range observed since the pandemic.

Increase uncertainty about domestic re-inflation. The escalation of the Middle East situation causes the high oil price period to last longer than the market expects, which will increase imported inflation pressure, pushing China’s price levels to rebound faster and, to some extent, support a reasonable recovery in China’s prices. Brent crude oil price growth and China’s PPI growth are highly positively correlated (as of February 2026, the 36-month rolling correlation coefficient is 0.67). It is expected that oil price increases will gradually transmit into PPI data and accelerate PPI growth turning positive. However, the correlation between crude oil price growth and China’s CPI growth is not stable (as of February 2026, the 36-month rolling correlation coefficient is only 0.07). This is mainly because domestic effective demand remains weak, and the distribution of enterprises shows a pattern of fewer firms upstream and more downstream firms. Competition in midstream and downstream markets is relatively intense, making it difficult for firms to pass upstream cost increases smoothly to downstream, squeezing profit margins and potentially weakening firms’ willingness to produce and invest. If high oil prices suppress external demand before the problem of insufficient domestic demand is clearly alleviated, it could further intensify the contradiction of strong supply and weak demand domestically, dragging on China’s price recovery. If the U.S. stock market crashes, a U.S. and even global economic recession cannot be ruled out, and the aforementioned drag may further increase.

Increase international pressure for currency revaluation. In recent years, strong Chinese export growth and persistently weak imports have significantly expanded the merchandise trade surplus. In 2025, China’s trade surplus crossed the $1 trillion mark, and in the first two months of 2026 it continued to record double-digit year-on-year growth. At the same time, the Bank for International Settlements published the renminbi real effective exchange rate index, which generally continued its downward trend since April 2022. Unlike the yen, whose real exchange rate weakened due to a decline in nominal exchange rate, China’s real exchange rate weakening is mainly due to domestic conditions of strong supply and weak demand and subdued price trends. From April 2022 to June 2025, the renminbi real effective exchange rate index fell cumulatively by 18.9%, while the renminbi nominal effective exchange rate index declined only 7.7%. Under the impact of the U.S.-Israel-Iran conflict, if global inflation rises while domestic inflation stays low, a widening inflation differential between home and abroad could cause the renminbi real effective exchange rate to resume its downward trend, giving some countries a pretext to put pressure on the renminbi to revalue.

Impact foreign direct investment willingness. Latest international balance of payments data show that in 2025, net inflows of foreign direct investment totaled $80 billion. Equity investment recorded net inflows of $89.1 billion, up $37.3 billion and $14.7 billion year-on-year, respectively, but it still remains at a historic low. According to the “2026 China Business Environment Survey Report” released by the U.S.-China Business Council, concerns about slower Chinese economic growth are the top challenge faced by surveyed companies operating in China, accounting for 64%. External demand plays an important role in China’s economic growth. In 2025, its contribution rate to GDP growth was 32.7%, the highest since 1998. If tensions in the Middle East drive up oil prices and in turn suppress external demand, it will further drag on China’s economic growth, increase difficulties for business operations, and affect foreign investors’ business deployment in China.

Be alert to contagion effects in financial markets. If the U.S.-Israel-Iran conflict lasts longer and its impact expands, it may force major global central banks to shift their monetary policy, tightening global financial conditions and intensifying concerns about financial stability. Against this backdrop, China’s domestic financial markets may face shocks stemming from Middle East developments that suppress risk appetite in the market, the U.S. private credit crisis, the burst of the AI bubble, and pressures such as the yen carry trade unwinding that may occur if Japan is forced to accelerate normalization of monetary policy. These shocks may generate spillover effects on domestic financial market operations through cross-border capital flows and market sentiment channels.

Of course, the evolution of the Middle East situation is both a challenge and an opportunity for China. It will help further highlight the resilience of China’s industrial and supply chains and strengthen confidence in China’s economy and currency among all sectors. To that end, China should focus on doing its own work, fully deepen reforms, promote high-quality development, accelerate the building of a new development paradigm, expand high-level opening up to the outside world, and turn “crisis” into “opportunity.” It should also strengthen risk monitoring and early warning, enrich the policy toolbox, and at the same time guide market participants to develop response plans on the basis of scenario analysis and stress testing to be prepared for any eventuality. In addition, it should improve prevention of extreme risks, better coordinate development and security, and continuously strengthen capacity building for national security in key areas.

(The author is the Global Chief Economist at Bank of China Securities)