Economic Update: Middle East

Economic Update: Unresolved conflict delays GCC recovery

• The GCC economy faces a marked contraction this year pending details of the US-Iran agreement to end the war.
• We expect energy flows, tourism and investor sentiment to gradually normalise as war disruptions subside.
• Looking beyond the conflict, we don’t expect the region’s business-friendly credentials to suffer lasting damage.

The interim agreement between the US and Iran is a significant step towards reaching a full-blown deal. A full return to normality in the Strait of Hormuz will likely take time, but the risk of a recession-inducing oil price spike has declined. Global GDP is expected to grow by 2.4% this year, 0.2ppt less than we projected three months ago, and 3.1% in 2027. 

The downward revision to our Middle East growth outlook has been notable since the conflict began in February. We forecast a 4.1% contraction in Middle East GDP this year (versus projected 3.6% expansion before the war), greater than the decline in the first year of the Covid pandemic. Kuwait, Iran, Iraq and Qatar stand out as the hardest hit, owing to their inability to avoid the disruption to regional shipping, war-driven infrastructure damage and tourism losses. 

Pending details, the deal should pave the way to a gradual recovery of GCC exports, investor sentiment and tourism. Our 2026 outlook for the GCC is weaker than three months ago, with GDP forecast to contract by 2.4% compared to a 0.2% decline projected previously. We expect Oman and Saudi Arabia to be the least negatively affected by the fallout from the conflict, with both economies continuing to expand this year. Although near-term risks remain, our baseline scenario still points to a pronounced recovery in regional growth next year and beyond, with 2027 GDP growth projected at 8.1%. 

Chart 1: Real GDP growth

The economic damage incurred in the last few months is substantial. Saudi GDP data for Q1 showed growth slowed to 3% y/y, with non-oil activities expanding by 2.9%, the weakest pace since the Covid pandemic. On a seasonally adjusted basis, GDP contracted 1.2% q/q, driven by a 6.8% fall in oil activities as the Strait of Hormuz disruption hit late in the quarter. Non-oil edged up 0.3% and government activities rose 1.4% q/q, indicating that the war shock has mostly transmitted through oil rather than broader domestic activity. 

Aside from Oman, all GCC producers as well as Iran and Iraq have suffered extensive oil and gas production losses since the start of the conflict. May data show regional production nearly halved from pre-war levels, with the decline deepening relative to March and April. Rerouting efforts, including by Saudi Arabia through the East-West Pipeline and the UAE through the Habshan-Fujairah pipeline, have helped prevent an even larger plunge in output. We expect recovery to start as soon as normal transit through the Strait is restored. Nevertheless, we forecast GCC oil sector output to contract by 14.5% this year, which will mark the steepest decline in several decades. We then expect a 23.5% rebound next year, driven largely by normalisation from a severely depressed base.

Meanwhile, oil prices have been volatile, easing below $85 per barrel as the interim agreement was announced. In our baseline forecast, we expect oil prices to remain above pre-war levels as exports gradually normalise, with Brent oil price averaging around $90 per barrel this year. In the medium term, we expect oil prices to be slightly lower than our pre-war baseline, as the UAE’s departure from OPEC+ allows for a gradual increase in its output towards the 5mn barrel per day production target once trade normalises. Against this backdrop, the UAE will speed up the construction of a new West-East pipeline that should double the capacity of export through Fujairah. 

Non-oil activity in Saudi Arabia and the UAE appears to be rebounding despite lingering geopolitical uncertainty. The May PMI surveys reported output growth reaching its strongest level in three months, driven largely by improved domestic demand. However, they remain below long-run averages, with weak export orders and price pressures from higher material and transportation costs are a common theme. Overall, we expect a 1.1% contraction in GCC non-energy sectors this year (compared to 4.2% growth pre-war) and a gradual recovery over the rest of the decade.

Travel and tourism losses will be felt for some time. Our current forecasts project a 30% decline in inbound arrivals to the GCC this year, reflecting the impact of heightened geopolitical uncertainty on travel demand, booking behaviour, and destination choice. Despite the weak near-term outlook, medium-term confidence in regional tourism growth remains strong, supported by ongoing infrastructure investment, capacity expansion and targeted tourism strategies. 

Lingering security risks are likely to sustain business and investor caution in the near term, weighing on investment decisions and moderating real estate activity, particularly in internationally exposed markets such as Dubai. Property prices have come under pressure after a period of strong growth, with recent data from the Dubai Land Department showing a drop in mortgage transactions and cash sales. Nevertheless, we think the risk of a lasting migrant outflow and a severe downturn in the real estate sector is low. Our assessment relies largely on on-the-ground observations, which suggest that majority of expatriates who departed following the outbreak of hostilities have returned as conditions normalised. 

As a lasting US-Iran deal takes shape, the fallout from the conflict has tightened regional financial conditions, exposing vulnerabilities through capital outflows, wider bond spreads, and weaker investor sentiment. Most GCC sovereigns carry relatively little debt and funding risks are therefore limited – in the UAE, the central bank’s liquidity management has alleviated immediate concerns. Bahrain stands out – its debt is above 130% of GDP and Moody’s recently lowered the outlook on its sovereign rating. That said, Bahrain has been able to count on support from neighbours, including Saudi Arabia and the UAE, and it successfully raised $1bn from an oversubscribed sovereign bond sale this month, marking the first offering from the region since the war began.

High-frequency fiscal data underscore the strain on regional public finances from the conflict. Countries face differing trade-offs depending on their fiscal space, existing expenditure commitments, and exposure to emerging security and resilience challenges. In Saudi Arabia, the budget deficit more than doubled to SAR125.7bn, or about 9% of GDP in Q1, driven by a decline in oil revenue and a surge in spending, particularly on subsidies, reflecting contingency outlays tied to the regional environment and an acceleration of Vision 2030 spending. In Qatar, the crisis brought oil and gas revenue to a halt, swelling the budget deficit to the largest since 2017. By contrast, Oman is more resilient and will run a surplus this year, thanks to its steady ability to export. 

GCC inflation dynamics remain uneven, with food prices the main source of upward pressure and inflation in this category strengthening in Kuwait, Oman and Qatar. By contrast, food inflation remains relatively subdued in Saudi Arabia, likely reflecting the mitigating effect of its larger domestic food production base and greater supply-chain resilience. Against this backdrop, we have raised our forecast for GCC CPI inflation in 2026 by a further 0.1ppt to 2.6% y/y. We continue to view price pressures as largely transitory rather than indicative of a sustained inflationary cycle. Accordingly, we expect average inflation to ease to 2.1% y/y in 2027 as temporary supply-side pressures dissipate. With near-term inflation elevated and transit through the Strait likely set to resume slowly, we expect the US Federal Reserve to keep interest rates on hold until December, and regional rate policies to follow suit.

Chart 2: Non-oil GDP recovery 

Elsewhere in the Middle East, war has imposed a heavy economic toll. We expect Iran’s GDP to shrink by 10.8% this year (we forecast a 9.4% contraction three months ago). Oil production and exports, which provide essential revenue and FX inflows, have been curtailed by the US naval blockade, while non-oil activity has been severely hit. In Iraq, oil exports have collapsed to a trickle and we're forecasting GDP to contract by around 22% this year, with a sharp 33% rebound in 2027 as oil exports normalise. Meanwhile, Lebanon faces a 6.5% contraction this year amid ongoing Israeli strikes, occupation in the south of the country and forced displacement of 20-25% of the population, putting it among the most affected countries in the world by the multi-front regional conflict. By contrast, Syria continues to reintegrate into the global economy after more than a decade of civil war. We anticipate GDP growth to average 9.6% over 2026-2027, supported by renewed investment, particularly in banking and energy, monetary reforms, and the gradual reopening of regional trade links.