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US, Iran likely to avoid full-scale armed conflict, rating agencies say

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US, Iran likely to avoid full-scale armed conflict, rating agencies say

Moody's and S&P Global Ratings warned of broad economic and financial shocks across the Middle East and the global economy should tensions between the U.S. and Iran escalate into full-scale military conflict, while noting that such a development is currently unlikely.

In separate bulletins, the two rating agencies affirmed their base case that both the U.S. and Iran would likely avoid an outright direct military conflict, amid heightened tensions in the aftermath of a U.S. airstrike that killed top Iranian commander Qassem Soleimani. The development has elevated event risk in the Gulf but any escalation will "remain contained" as all parties involved recognize that direct conflict would be deeply destabilizing for the region, according to S&P.

"We consider that a potential intensification of proxy conflicts will further undermine confidence and investment in the region," S&P added in its bulletin.

In particular, further escalation could be damaging to Iraq's security situation, although the country's already low credit rating takes into account a high degree of political risk, S&P said.

Abu Dhabi in the United Arab Emirates, Kuwait, Qatar and Saudi Arabia would be relatively cushioned against external shocks by their large reserves of readily available government assets. Bahrain and Qatar are more vulnerable to capital outflows due to conflict because of their respective banking sectors' high external financing needs, while Oman's reliance on external debt makes it vulnerable to conflict-induced upward pressure on debt-servicing costs.

Moody's noted that lasting conflict in the region would primarily affect oil and gas production in Iraq and Gulf Cooperation Council member states, with implications on the growth of the non-hydrocarbon sectors of their respective economies. Countries just outside the Gulf, such as Lebanon, would also be affected.

"A lasting conflict would have wide-ranging implications through broad economic and financial shock that significantly worsen operating and financing conditions," Moody's said.

Dubai in the UAE, for example, would see a hit to its logistics and tourism sectors should outright armed conflict break out in the Gulf, while oil prices are expected to go up around the world. Oman is the least exposed country to potential disruptions in critical production and transportation infrastructure, as it sits just outside the Persian Gulf and has maintained a neutral stance in the face of regional geopolitical tensions.

Iraq and Lebanon would have very limited capacity to absorb shocks, while even relatively stronger-rated countries such as Kuwait, Qatar and the UAE would find it challenging to cope with prolonged and broad conflict, Moody's said.