The escalating conflict in the Middle East is beginning to ripple across global markets, raising questions about oil prices, inflation, financial stability, and economic growth. 

For Asian economies that rely heavily on imported energy and overseas employment in the Gulf region, the conflict presents a range of risks that extend beyond the battlefield.

Sri Lanka, still recovering from its recent economic crisis, is particularly exposed through multiple channels including energy imports, remittances, tourism flows, and global financial markets. While the immediate economic impact remains uncertain, analysts say the trajectory of the conflict will determine whether the consequences remain manageable or evolve into a broader economic shock.

Against this backdrop, the Government of Sri Lanka has also moved to clarify its diplomatic position, highlighting neutrality while preparing contingency plans to manage potential economic fallout.

Oil prices at the centre of economic risk

Energy markets have reacted quickly to the escalation in the region. Oil prices remain the most immediate transmission channel through which the conflict could affect Asian economies.

Economist Intelligence Unit Regional Director – Asia-Pacific Alex Holmes, speaking to The Sunday Morning, said that the Strait of Hormuz remained the central pressure point in global energy markets. The narrow waterway carries a large share of the world’s oil shipments, making it a critical strategic chokepoint.

“Passage has already been disrupted and the threat of extended closure of this critical route is the main factor adding a premium to global oil prices,” Holmes explained.

Brent crude prices rose sharply to about $ 82 per barrel in early Asian trading following the escalation but later eased closer to $ 77. Even so, prices remain above the roughly $ 73 level recorded in late February and significantly higher than the $ 63 level seen earlier that month.

Although Iran accounts for only 3–4% of global oil production, its control over the Strait of Hormuz gives it strategic leverage over global energy flows. More than 20% of the world’s oil supply moves through this corridor.

Holmes said global oil prices were expected to spike in the short term but were unlikely to remain elevated indefinitely.

“Our best estimate is that oil prices will spike in the short term, but that will fade as the conflict and risk premium ease and the supply response from other parts of the world feeds through,” he said.

The Organization of the Petroleum Exporting Countries (OPEC) and its partners have already signalled a supply response, announcing plans to increase production by about 206,000 barrels per day beginning in April.

Even so, Holmes expects average oil prices in the coming year to settle slightly above previous forecasts.

“All told, benchmark oil prices are likely to average $ 70–80 per barrel in 2026, compared with a previous baseline forecast of $ 68 and last year’s average of about $ 69.”

Inflation pressures likely but manageable

Higher oil prices tend to feed directly into inflation, particularly in emerging economies where fuel prices play a significant role in household expenditure.

Across Asia, most economies rely heavily on imported energy. This means any sustained increase in oil prices would eventually be passed through to consumers through higher transport costs, electricity tariffs, and production expenses. Holmes noted that the effects would be uneven across the region.

“The vast majority of Asian economies are net importers of oil, and a jump in prices at the global level will feed through to consumers indirectly via producer prices and directly via fuel prices,” he said.

Countries such as Thailand, India, Indonesia, and the Philippines have relatively large fuel components in their consumer price baskets, making them particularly vulnerable to rising energy costs. Malaysia is also exposed, although partial subsidies cushion some of the impact.

However, Holmes does not expect a repeat of the inflation surge seen after Russia’s invasion of Ukraine in 2022. Global inflation conditions today are significantly more subdued.

Headline inflation rates across many economies remain relatively low, while global food commodity prices, particularly rice, have remained stable. In addition, weak export prices from China continue to exert downward pressure on global goods inflation. Taken together, these factors are likely to moderate the inflationary impact of higher energy prices.

Financial markets reacting cautiously

Financial markets across Asia have already shown signs of nervousness in response to the conflict.

In Sri Lanka, the Colombo Stock Exchange experienced a sharp correction earlier this week, triggering a circuit breaker after the All Share Price Index dropped more than 1,200 points in a single trading session.

HNB Stockbrokers Manager – Research Cheran De La Harpe said the decline showed investor sentiment rather than a sudden deterioration in domestic economic fundamentals.

“The sharp correction on Tuesday (3), with the ASPI declining 1,290 points, suggests an element of panic-driven selling,” he said.

He added that early trading the following day indicated some stabilisation as investors reassessed the situation.

“Markets are likely to remain headline-driven over the next two weeks, with volatility persisting until there are clear signs of deescalation of tensions.”

Across the Asian region, equity markets have also reacted but with less dramatic swings. Major indices initially declined by around 2% before experiencing further modest pullbacks. According to De La Harpe, the pattern suggests investors are pricing geopolitical risk but do not yet anticipate a full-scale economic disruption.

Risks to SL’s external sector

For Sri Lanka, the most significant economic risks stem from the country’s external sector.

The Middle East plays a central role in Sri Lanka’s economic linkages through remittances, trade routes, and tourism connectivity. Any prolonged conflict could disrupt these channels simultaneously.

“The key pressure point remains the Strait of Hormuz, which carries roughly 20% of global seaborne oil trade,” De La Harpe said.

He warned that prolonged disruptions could push oil prices significantly higher than current levels. “Any sustained disruption would tighten supply and could push oil prices towards the $ 90–100 per barrel range.”

Higher energy prices would directly affect Sri Lanka’s domestic economy. If the country continues to apply its cost-reflective fuel pricing mechanism, higher global prices would translate into increased domestic fuel costs, raising transport and production expenses across the economy. If authorities intervene to cushion prices, the financial burden could fall on the State.

Potential losses at the Ceylon Petroleum Corporation could add fiscal pressure at a time when Sri Lanka remains under an International Monetary Fund programme requiring strict fiscal discipline.

Pressure on the rupee and reserves

Another concern relates to currency stability. Periods of geopolitical tension often trigger a strengthening of the US Dollar as investors seek safe-haven assets. A stronger dollar increases the cost of imports and raises the burden of dollar-denominated debt for emerging economies.

Sri Lanka’s external sector could also face pressure through remittance flows. Workers in Gulf countries send home a significant share of the country’s foreign exchange earnings.

“The Middle East accounts for roughly 40% of Sri Lanka’s total remittance inflows, which was $ 8.1 billion in 2025,” De La Harpe noted.

If economic activity in Gulf economies slows due to the conflict, remittance flows could weaken over time. Combined with higher import costs and potential disruptions to tourism earnings, such pressures could affect the stability of the Sri Lankan Rupee.

Attempting to defend the currency aggressively by selling reserves would carry risks, particularly given the country’s limited external buffers.

Tourism and aviation disruptions

Tourism is another sector vulnerable to the unfolding situation. Airspace closures and flight cancellations across parts of the Middle East have already affected global aviation routes. Many long-haul flights between Europe and Asia pass through Middle Eastern hubs.

“Sri Lanka remains heavily dependent on Middle Eastern transit hubs, with over 30% of arrivals in 2025 linked to Gulf carriers and connections,” De La Harpe said.

Flight disruptions could therefore affect visitor numbers in the short term, particularly from European markets that form a large share of Sri Lanka’s tourism base. Neighbouring destinations such as the Maldives face similar risks due to their dependence on long-haul travel routes passing through the Gulf.

Export sectors facing cost pressures

Trade flows could also face indirect effects. Maritime disruptions in the Red Sea and surrounding areas have already forced shipping companies to reroute vessels, extending transit times and raising freight costs.

Sri Lanka’s tea industry is particularly exposed to Middle Eastern markets, while apparel exporters rely heavily on efficient shipping routes to Europe and North America.

According to De La Harpe, the primary impact may come through higher costs rather than a sudden collapse in export volumes. “Overall, the risk is more to margins than to immediate volume collapse, unless disruptions become prolonged.”

Competitor countries in the region, including Bangladesh, face similar challenges as they depend on comparable shipping routes for their export industries.

Supply chains and global trade

Beyond Sri Lanka, disruptions to maritime trade routes are affecting global supply chains. Attacks on shipping in the Red Sea have already forced many vessels to avoid the Suez Canal and travel around the Cape of Good Hope, adding weeks to transit times.

These longer routes increase freight costs and complicate production schedules for industries that rely on tightly coordinated supply chains. Holmes said countries with complex manufacturing networks, such as Japan, were particularly exposed to these disruptions.

However, many firms have built greater resilience into their supply chains since the pandemic, including diversified sourcing and larger inventory buffers.

SL declares neutrality

Amid these global developments, the Government has clarified its diplomatic stance. President Anura Kumara Dissanayake said that the country would remain neutral in the conflict between the US and Iran while continuing to uphold international obligations.

“Particularly in the context of this Middle East conflict, as well as in any international dispute, our position and neutrality dictates that we shall not, under any circumstances, permit our land territory, maritime zones, or airspace to be utilised in a biased manner by any nation engaged in a conflict,” the President said.

The statement came during a special media briefing at the Presidential Secretariat in Colombo addressing recent developments involving Iranian naval vessels near Sri Lankan waters.

The President explained that Sri Lanka’s actions were guided by both neutrality and humanitarian considerations. “As a nation and as a State, while safeguarding neutrality, we place humanity above all else,” he said. “We will never hesitate to protect humanity.”

Sri Lankan authorities recently conducted a rescue operation after a vessel came under attack near the country’s maritime zone. The operation resulted in the rescue of several individuals and the recovery of bodies from the incident.

The Government has also been managing the arrival of another Iranian vessel whose crew required assistance. According to the President, arrangements have been made to bring 208 individuals ashore in Colombo while the vessel itself will be moved to the Port of Trincomalee.

Govt. prepares economic response

Beyond diplomatic considerations, the Government has also begun evaluating the potential economic consequences of the conflict. A high-level meeting chaired by the President examined risks to fuel supplies, tourism, exports, food security, and inflation.

Officials reviewed the country’s current fuel reserves and discussed contingency plans to maintain adequate stockpiles in the event of supply disruptions. The meeting also considered the possibility of congestion at the Colombo Port should maritime routes in the Middle East face temporary closures.

Authorities discussed measures to facilitate shipping companies and maintain smooth port operations. Tourism officials are exploring alternative air travel arrangements to mitigate disruptions caused by airspace closures in the region. 

The Government is also assessing potential measures to encourage investment in emerging sectors such as data centres and digital infrastructure as part of broader economic planning.

Calls for diplomacy and stability

At the diplomatic level, Foreign Minister Vijitha Herath has held discussions with several counterparts from Gulf countries, including Jordan, Bahrain, Lebanon, and Kuwait.

These conversations focused on the evolving regional situation and the safety of Sri Lankan nationals living and working in the region. The discussions also emphasised the need for de-escalation and diplomatic engagement to prevent further instability.

Sri Lankan officials say the Government’s approach is to closely monitor developments while safeguarding the country’s economic stability.

If hostilities remain contained and oil supply routes stay open, the global economic impact could remain relatively limited. However, any escalation involving critical energy infrastructure or prolonged disruption to maritime trade routes could quickly amplify economic pressures.