Tax rises loom as Hormuz crisis threatens to blow £7bn hole in Chancellor's plans

The ongoing war in the Middle East has transformed a regional security issue into a global economic crisis. Prolonged disruptions in the Strait of Hormuz have driven up oil, gas, freight and insurance costs, exacerbating inflation and constraining growth. While wealthier nations can absorb part of the shock, developing countries like Pakistan are hit harder, facing higher import bills, weakened external balances, higher inflation and reduced monetary or fiscal flexibility.

The Strait of Hormuz, through which roughly a fifth of the world's oil and gas supplies pass, continues to dictate the health of the global economy, seven months after the initial US-Israel strikes on Iran. Despite diplomatic efforts, the situation remains tense. Pakistan, hosting US and Iranian delegations in April following a two-week ceasefire, saw an interim agreement collapse shortly after.

Iran has proposed a revised plan to release frozen funds, lift oil sanctions and end the naval blockade, with nuclear talks to begin within seven days. However, President Trump has dismissed the plan as unacceptable, and the two sides are wagering on the outcome. While the global economy appears stable at first glance, the International Monetary Fund's July update projects global growth of 3% this year but raises its inflation forecast to 4.7%.

Developing Asia, particularly Pakistan, stands to lose significantly if the disruption persists beyond a year, with regional growth potentially falling by up to 1.3 percentage points in FY27. The Gulf serves as a temporary cushion, with Pakistan receiving record remittances from overseas workers. However, this relief is contingent on the war not escalating further.

Diplomatic efforts have been the preferred course, with Islamabad maintaining open channels to Washington, Tehran and the Gulf. China, Iran's largest trading partner, has also shown interest in resolving the conflict, with Chinese President Xi Jinping offering to help end the war and urging the reopening of the Strait of Hormuz.

Despite these efforts, the US has not yet forced the Strait open, and Iran remains resistant to concessions. Both sides now recognize the need for compromise, with Washington suggesting a verified reopening of the Strait in exchange for easing the blockade, while Tehran should drop transit tolls and agree to independent verification.

The mediators holding the key to any settlement are Pakistan, Qatar and Oman. While force has not yielded the desired results, other nations now hold pieces of the solution. Both sides must concede something significant to gain something substantial. Washington could accept a sequence of events, starting with a verified reopening of the Strait in exchange for easing the blockade, with nuclear issues addressed in a separate, time-bound round.

Tehran must abandon transit tolls and accept verification by independent parties. Neither side has demonstrated the ability to emerge victorious. With five months remaining until the war's first anniversary and the ADB's worst-case scenario in sight, there is still time for a deal, provided Washington and Tehran engage in meaningful dialogue and remain committed to resolving the crisis.