The Iran-Gulf War and its economic impact on Gulf countries

The war between Iran and the Gulf countries has sparked comparisons with the Vietnam conflict, not so much for the political implications, but for the issues of cost and duration. Although the political impact of this war on the U.S. midterm elections is still uncertain, the economic effect is already evident and is spilling over into the Gulf countries, which did not choose this conflict and cannot vote to end it, but which will bear the economic costs for a long time after its conclusion.

Five accumulating economic costs

There are five main economic costs that are hitting the Gulf countries and their trading partners, and none of these will disappear in the short term as policymakers hope.

1. Energy

The closure of the Strait of Hormuz pushed Brent prices to nearly $120 a barrel in April, forcing many Asian importing economies to ration fuel as early as the second week of the conflict. Countries like Sri Lanka, Pakistan, and Bangladesh have introduced a four-day work week or brought forward holidays to save energy. These indirect costs are passed on to consumers through prices and should ease over time.

However, for the Gulf countries, the costs are capitalized, as they have to pay to rebuild damaged energy infrastructure and invest both in modernizing existing logistics and developing new export routes to ensure long-term security.

Currently, the Strait of Hormuz is in an intermediate situation: open according to the United States, closed according to Iran, with maritime traffic reduced to a fraction of pre-conflict levels. Only five merchant ships crossed the strait on August 25. Threats and attacks by the Houthis in the Strait of Bab el-Mandeb suggest that this second regional choke point is now also involved.

The disruption in the Strait of Hormuz has forced Gulf countries to rely on secondary transport options, such as pipelines and trucks, to maintain energy flows. The simultaneous pressure on two of the world's main maritime corridors will force Gulf countries and their trading partners to treat the situation not as a temporary shock, but as a feature of the new operating environment, investing accordingly in pipeline, storage, and export capabilities outside the strait.

2. Reconstruction

Iranian and proxy militia attacks have damaged both energy and water infrastructure across the region, creating a capital expenditure overload that will have to be addressed immediately after any peace agreement or even during a prolonged truce.

This situation is unprecedented for the region, as in the past, damage in one country could be absorbed in the short term by the capacity or resources of a neighbor. This time, simultaneous reconstruction will create competing demand for the same pool of private capital.

The Gulf sovereigns will therefore have to finance a substantial portion directly, drawing from a broad pool of sovereign wealth estimated at around six trillion dollars. However, these assets are not all liquid, meaning that private and institutional investors will be called upon just as they are reassessing their exposure to the region. Views on the cost of capital, investment time horizons, and geopolitical risk are becoming increasingly reactive to events on the ground.

3. Tourism

This cost is the least visible in financial markets, but perhaps the most evident for those taking a weekend flight or leaving the region's most popular tourist spots at night. Tourism and commercial traffic have decreased significantly. For example, hotel occupancy in Dubai fell from 84.7% in February to about 22.8% in mid-March, then rose to 82.2% during Eid and stabilized around 45% in June. In Riyadh, occupancy fell by 17.9%, to 49.3%. Saudi Arabia's Vision 2030, the position of the United Arab Emirates as a regional financial headquarters and tourist hub, and Qatar's post-World Cup strategy all depend on the assumption that people will continue to arrive. However, it is impossible to assess how growth forecasts should change as the conflict continues to swing between military strikes and temporary truces.

With the conflict still ongoing, this pause could extend into the fall, with some residents remaining abroad where their work and family circumstances allow. Visitor confidence is harder to rebuild than any damaged airport terminal. If it does not recover, the Gulf will have less revenue to help cover the reconstruction bill.

4. Capital

This cost can be assessed in three ways. First, it has shifted, even if not where one would expect. Gulf governments have continued to take on debt during the conflict, their spreads have not widened significantly, and access to international markets remains intact. For example, Bahrain raised one billion dollars in ten-year bonds on June 4 at a yield of 7.125%, slightly higher than the 7.1% yield paid on twelve-year bonds issued one month before the war. The cost has instead fallen on issuers who do not have a sovereign budget behind them. Sukuk issuances and initial public offerings have been largely suspended. There were forty-four new offerings last year on the Saudi stock exchange, and only eight so far this year. Private placements continue to occur for stronger companies as an alternative to public issuances, but at levels far below those expected before the conflict. For second-tier companies, the capital window has narrowed sharply.

Second, private investors are daily reassessing regional risk amid the intermittent opening and closing of the Strait of Hormuz and continued missile and drone attacks. Many investment committees still refuse to consider equity and debt opportunities in the region. For those still operating, approvals of letters of intent are taking longer and generally require higher interest rates and tighter clauses to compensate for the increased risk of default.