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Rising Sovereign Event Risk in The Gulf is Testing our Base Case of No Direct Military Conflict

S&P Global Ratings today said that the killing of Iranian general Qassem Soleimani by the U.S. over the weekend and its ongoing fallout has rapidly escalated event risk in the Gulf region. For now, this development does not alter our base-case assumption that any military action by either side will not lead to a fully fledged direct military confrontation.

We continue to believe that any escalation will remain contained given that a direct conflict would be economically, socially, and politically destabilizing for the entire region, including U.S.-Gulf allies. We consider that a potential intensification of proxy conflicts will further undermine confidence and investment in the region. Our ratings on Gulf sovereigns already take into account a certain level of regional geopolitical volatility.

If a protracted and wider conflict emerges, assuming export routes remain functional, the fiscal benefit of potentially higher oil prices for Gulf sovereigns will likely be offset by the adverse effect on capital outflows and weaker economic growth, in our view (see "How U.S.-Iran Tensions Might Affect Gulf Sovereign Ratings", published June 11, 2019, on RatingsDirect and Related Research). As previously stated, in such a scenario Abu Dhabi, Kuwait, Qatar, and Saudi Arabia would likely be better cushioned by their large stocks of deployable government external assets. On a flow basis, we view Bahrain and Qatar as more vulnerable to outflows given their high external financing needs, relating to their respective banking sectors. Oman's reliance on external debt is a key contributor to our negative outlook on the 'BB/B' sovereign rating; a higher risk premium in the event of escalating conflict could further pressure already-rising debt-servicing costs.

A further escalation could be especially destabilizing for Iraq's security situation, particularly if reprisal attacks take place in the country. However, the low rating level already incorporates a high degree of political risk and the deep-rooted challenges the country faces.