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Developments in the Israel-Iran conflict have heightened downside risks to sovereign, bank, and corporate credit in the Gulf region. The transmission channels that could pressure regional credit include disruption to key transportation routes, fluctuating energy prices and disruptions to energy production, reduced tourism, capital outflows, higher security spending, and weaker consumer and investment confidence.

What We're Watching

The ongoing escalation of the Israel-Iran conflict has heightened geopolitical risks across the Middle East, challenging previous assumptions regarding regional stability and creditworthiness. As military operations intensify, S&P Global Ratings is closely monitoring the potential for broader implications that could affect sovereign ratings, banking systems, and corporates in the region.

Key developments that would reflect material conflict escalation include U.S. involvement, attacks by Iran on energy facilities and/or U.S. bases in the broader region, and disruptions to critical trade routes—particularly the Strait of Hormuz (through which 20%-30% of the world's oil supply is transported).

The conflict has already resulted in increased volatility in energy prices and supply disruptions due to higher freight and insurance rates, and security risks. Sustained conflict or higher tensions would also prompt economic ramifications—such as reduced tourism, capital outflows, and increased security expenditures, as well as weaker consumer and investor confidence. For net oil-importing sovereigns, higher energy costs could underpin inflation and reduce monetary space for central banks to lower interest rates.

Corporate ratings in the region would likely see similar effects, since approximately 50% include certain levels of government support. In addition, companies could experience a deteriorating operating environment that affects consumer spending, business prospects, and investor sentiment.

Based on our outlined scenarios, we currently view the base case as between the moderate and high-stress scenarios, with risks tilted to the downside.

What We Think And Why

The conflict is fast evolving. Although not our base case, the current landscape suggests a higher likelihood of prolonged hostilities and regional instability—which could adversely affect sovereign creditworthiness, business confidence and operating environment for corporates, and banks' creditworthiness across the Gulf Cooperation Council (GCC) region and neighboring countries.

While much of the GCC region retains substantial financial buffers that anchor ratings, the duration and severity of disruption remain critical variables. Notwithstanding higher oil prices of about 10% since the start of the conflict, we believe that prices will weaken over the medium term as OPEC+ continues the accelerated unwinding of its production cuts, while global demand growth is weakening. And although higher oil prices could benefit oil-exporting nations, the overall effect on the region will depend on sustained global demand, materialization of planned expansion of oil supply, and uninterrupted trade routes.

Efforts in the GCC region to diversify away from oil revenues are ongoing, but their dependence remains a potential vulnerability and their fiscal and external positions could deteriorate if the conflict disrupts production or trade routes. (GCC economies export most of their oil to Asian markets, including China, Japan, and South Korea.)

Comparatively, Oman's export terminals avoid the Strait of Hormuz, and both Saudi Arabi and Abu Dhabi have pipelines which can divert a portion of their crude production to export locations that are less at risk of blockage. However, we believe that the Strait closure would also disrupt Iranian exports, and we view that as a last-resort action.

Fluctuating energy prices and disruptions to energy production could also affect other downstream industries—primarily petrochemicals, which remain an important diversification avenue for most GCC oil countries and a large corporate sector in the region.

Increased military spending in response to heightened threats could strain fiscal budgets, particularly for countries with already vulnerable economic positions. Nations like Bahrain and Jordan have more limited fiscal buffers than larger hydrocarbon exporters in the GCC region. "Risk-off" sentiment could lead to higher funding costs and reduced banking system liquidity. Capital flight may occur as investors seek safer havens amid rising geopolitical tensions, further straining credit conditions.

GCC banking systems could see risk transmitted through outflows of foreign funding (with non-resident investors potentially exiting the GCC region as confrontation intensifies), outflows of local funding (with the assumption that this would only materialize in the event of a broader regional or more global conflict), and a spike in default rates among banks' corporate and retail clients (as geopolitical instability affects interconnected regional economies, particularly those reliant on oil revenues).

Further escalations could have wider supply chain issues for most corporates. While they have some recent experience with Red Sea closures, the Strait of Hormuz is far more critical for GCC trade flows. So far, rated GCC companies have been able to manage the escalated cost and time of rerouting goods to avoid the Red Sea without seeing a significant impact on their margins, sometimes even passing the additional cost onto customers.

Additionally, the escalation in hostilities threatens to deter tourism. Countries that rely on tourism for a substantial portion of their GDP, such as Egypt and Jordan, could face significant fiscal challenges if visitor numbers decline. Energy importers face dual pressures from elevated oil prices and reduced tourism flow, compounding already fragile external positions. Against this backdrop, hospitality, tourism, airlines, real estate, and consumer goods are the sectors in the GCC region that could see a severe impact if geopolitical pressures escalate and regional and nonregional allies are drawn into the conflict. This could also significantly affect population trends in the region—especially in the UAE, where most residents are expatriates.

Weaker consumer confidence and market sentiment would reduce consumer goods and discretionary spending. For example, in Dubai and Riyadh, capital outflows could be detrimental to residential real estate prices (as these cities have had strong momentum over the last three years and have higher reliance on expatriates and international investors), while reduced tourism would exacerbate the impact for retail real estate operators (with lower footfalls and spending).

Refinancing risks could materialize especially for low-rated issuers and underperforming companies. At the same time, corporate and infrastructure spending could be paused or cancelled if preserving liquidity becomes an imperative, especially in markets with large investment spending—such as Saudi Arabia focused on funding Vision 2030, Qatar on North Field expansion, and the UAE on various infrastructure projects.

What Could Change

Despite these challenges, many regional governments (including Saudi Arabia, the UAE, Kuwait, and Qatar) have built substantial liquid asset buffers and have a track record of aiding weaker sovereigns (like Bahrain, Egypt, and Jordan) in periods of stress. This resilience has helped shield the region's financial systems from the worst effects of previous geopolitical shocks. We believe banks have sufficient external liquidity to cover most outflows, assuming they can liquidate their external assets.

However, the trajectory of the Israel-Iran conflict remains uncertain. Several factors—including the potential for escalation of military engagements and/or diplomatic developments, alongside changes to proxies, regional dynamics, and global economic conditions—could significantly alter the current risk landscape.

The role of proxy forces in the conflict is a critical element to watch. If groups such as the Houthis in Yemen or Iranian-supported militias escalate their activities, it could lead to further disruptions in maritime trade and energy exports, compounding the existing economic pressures.

Potential for renewed diplomatic efforts could mitigate some risks. However, public statements by the respective leaders and the Trump Administration suggest that a diplomatic resolution may be increasingly elusive. Hostilities and increased regional instability could be prolonged and affect sovereign credit ratings if parties fail to engage in meaningful dialogue.

At large, the broader global economic environment (including demand for oil and geopolitical dynamics outside the region) can also influence how scenarios unfold. Ongoing trade tensions and shifts in U.S. foreign policy could have unforeseen consequences for regional stability and affect sovereign creditworthiness.

Writers: Riccardo Bellesia and Molly Mintz.