Navigating the Red Sea crisis: Implications for global supply chains
This article is authored by Ananya Raj Kakoti and Gunwant Singh, scholars, international relations, Jawaharlal Nehru University, New Delhi.
Asia’s cargo deliveries and supply chain were thrown into uncertainty during the peak holiday season following Houthi militant attacks on ships plying the Red Sea, which connects to the arterial route to Europe through the Suez Canal. Shipping lines, led by the world’s second-largest container shipping company AP Moller-Maersk and many others, have since suspended vessels on the route, which accounts for around 15% of the world’s shipping traffic and 30% of global container traffic. Houthi militants have attacked over 30 vessels, saying they are targeting those with a connection to Israel, which is locked in a war with Hamas. The rebels have also been launching drones and missiles against Israel, more than 1,000 miles (1,600km) away.
The redirection of ships around the Cape of Good Hope has extended travel times significantly, potentially adding up to two weeks to the journey or increasing transit time between Asia and Europe by 30-40%. This shift in routes could result in higher import costs for perishable food items like cheese, butter, salmon, and wine, as well as potential disruptions to exports of electronics and automobile parts from Asia to Europe.
The disruption in freight operations is expected to prompt changes in supply chain dynamics, potentially leading to shifts in the movement of goods within Asia. The recent militant attacks have exacerbated congestion in the Suez Canal, which has already been affected by low water levels due to a regional drought since July-August. Logistics and forwarding firms are concerned about the impact on shipping, likening the situation to a less severe version of the supply chain crisis witnessed during the peak of the pandemic. According to global trade solutions provider Flexport, approximately 90 percent of container vessels bound for the Suez Canal are either pausing or rerouting. This could reduce global capacity by a quarter, driving up prices, and causing shipment delays.
The disruptions have prompted carmakers Tesla and Volvo to halt some production in Europe due to component shortages. Executives warn that without a resolution in sight, manufacturers in other sectors are likely to be affected as well. If manufacturers cannot access key components, they may cancel orders for other unnecessary parts, as they are unable to produce the final product. This situation is exacerbated by the high cost of relying on inventories to mitigate the supply crisis, attributed to elevated interest rates.
Supply chain pressures, which eased throughout most of 2023 and fell below historical averages, began increasing in the second half of last year, now returning to pre-Covid-19 levels, according to Jamus Lim, associate professor of economics at ESSEC Business School, Asia-Pacific. Global shipping costs have been rising steadily since hitting lows early last year, with a brief spike in November following the Houthis' initial Red Sea attacks. The re-emergence of supply chain disruptions is seen as the biggest potential upside risk to inflation in the year ahead.
Investors have hoped for United States (US) Federal Reserve interest rate cuts to boost consumer spending and economic growth after a series of rate hikes. Central banks in Asia and other regions typically follow the Fed's lead.
While current data are concerning, they have not yet reached worrying levels. However, if inflation rates persist above the Fed's 2% target into the middle of the year, it could be challenging for the Fed to implement a rate cut cycle, despite market expectations.
Analysts suggest that the current disruptions in the global supply chain are just the beginning. The impact of ongoing shipping disruptions is starting to affect production, with supplier delivery times globally, including in major regions such as the United Kingdom and European Union, lengthening for the first time in a year in January. The longer the shipping disruption persists, the more delays and disruptions to production can be anticipated.
The recent missile attack by Houthi rebels on a Belize-flagged ship on February 19, 2024 has dashed hopes of resolving the shipping backlog between Asia and Europe, especially as freight rates were starting to stabilize. Consequently, retail consumers are anticipated to face higher costs. This disruption in global trade is now affecting retailers due to dwindling spare part inventories, sourced by western manufacturers from Asia. As a result, concerns about inflation have arisen, casting doubt on the likelihood of central banks reducing interest rates in the near future.
In one way or another, the cost of goods is being impacted by the ongoing shipping disruption. The longer it persists, the more likely it becomes that companies will pass on the price to consumers. This impact is expected to be more keenly felt as retailers begin restocking shop shelves for spring in approximately a month. Following a doubling of rates in the aftermath of the attacks, carriers had added more vessel capacity, and the demand rush before the Lunar New Year had subsided. However, the incident occurred concurrently with the US military's acknowledgment of conducting new airstrikes targeting the rebels, indicating that the unrest is unlikely to diminish. Concerns about a potential escalation of conflict in West Asia could lead to rises in energy and food prices, disrupting the global disinflation momentum.
The growing crisis in the Red Sea poses a significant global security concern, necessitating a united response from the international community. Currently, it is advisable for the US and western nations to refrain from exacerbating tensions and resist the temptation to resort to military actions in addressing the crisis in the Red Sea and Yemen. Instead, there should be a focus on enhancing international cooperation and pursuing a diplomatic resolution, which should be widely supported as the preferred approach to tackling the Red Sea crisis.
This article is authored by Ananya Raj Kakoti and Gunwant Singh, scholars, international relations, Jawaharlal Nehru University, New Delhi.
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