While conversations around this were already in the picture even before the war, it is fair to assume that the war might speed up this process as growth outlooks are revisited and revisions are made across the world. Analysts have already accounted for a global slowdown and revised their growth forecasts down with some even projecting a possible recession depending on how long the war progresses. However, one thing that runs deeper than the topline numbers is how the world may perceive growth in itself following the consequences of the current war as well as the structural changes that it may amplify. Traditional models that drove the global economy over the past 30+ years or so may change to fit a world with severe debt and high geopolitical fragmentation. Keeping track of such adjustments that could possibly re-define global capital and trade flows, and adapting accordingly could be the x-factor that separate the winners and losers in this newly emerging global order.

What are some prominent structural changes that define the new world?

The Artificial Intelligence (AI) boom is the most obvious one here. In the latter half of the 20th century, some of the brightest minds in the United States and the Soviet Union were focused on the race to develop nuclear weapons. Today, it’s a different kind of competition - this time with China - centered on achieving technological dominance, particularly in AI. Similar to these two giants, other developed nations and emerging economies are also aligning themselves to this age of AI with massive investments in technological infrastructure. Data centres emerged as a major force shaping global investment in 2025 driven by surging demand for AI infrastructure and digital networks. Similar to countries that attract such investments, more emerging economies may also look forward to ride this wave and place themselves within these supply chains that may re-define domestic policies within countries.

Defence spending is another prominent feature in this newly emerging order. As competition intensifies and more inter-state conflicts are expected in future, countries are heavily increasing their share of expenditure allocated for defence. 2025 turned out to be the 11^th consecutive year of rising global military expenses with defence spending as a % of GDP reaching 2.9% - the highest since 2009. This trend may present a series of opportunities particularly to the players within those supply chains that provide and assist the production or exchange of advanced military technologies and materials. This could also present a significant challenge to policymakers by restricting other fundamental investments geared towards areas such as education and healthcare that drives more longer-term growth and productivity.

Conflicts in the Gulf have consistently proven that being entirely dependent on Middle-eastern fuel and energy pose a significant threat to countries. Hence, achieving energy independence have made its way to the priority list of world leaders that could define domestic strategies in the years to come. The EU for instance is currently accelerating its efforts in this direction and setting the trend for the rest of the world. Following the heavy disruption faced due to the current crisis, the commission launched its latest initiative - AccelerateEU - the toolbox to bring immediate relief to European households and industries, especially the most vulnerable ones, while putting Europe on a steady pathway to energy independence. Climate risks and the transition towards green technologies compliments this further as growth and development of countries in this new age will be more closely linked to developing more sustainable energy sources.

What are some downside risks prevailing in this new context?

While the above-mentioned trends may provide policymakers, investors and businesses plenty of room for growth, it’s also important to note that it’s happening on the backdrop a global environment that is drowning in unprecedented levels of debt. The IMF says global public debt could exceed 100% of GDP by the end of the decade. Governments around the world now owe nearly $100 trillion in public debt. That’s almost double what they owed just a decade ago. While mature markets – particularly due to massive investments in AI account for most of this growing levels of debt, emerging markets have also reached a new high of more than $115 trillion, with Brazil, Russia, South Korea, Poland, and Mexico following China in debt accumulation. While increasing government borrowing serves as the main reason behind debt accumulation, the ability for authorities to operate in such tight fiscal conditions in the long run while maintaining low interest rates is the common question monetary authorities face across the world. Even though an immediate fallout is not within the cards as of yet, this approach of running large deficits and financing them using debt raises concerns around the long-term sustainability of public budgets across the world.

Another not-so immediate but certainly an area that may pose a new kind of challenge is the demographic shift that happening across labour and consumer markets across the world. This is also an area that indicates divergent implications across regions that could be increasingly visible with time. For instance, according to the United Nations, while Central Asia continues to experience youth-driven population growth, with a rising share of working-age people offering significant economic potential, many European countries are grappling with shrinking and ageing workforces, as fertility rates are low and populations become older.  A number of countries – particularly in the EU and East Asia - are already having to deal with increasingly ageing and shrinking population growth which have caused disruptions in domestic markets and require the need for carefully devised policies to face a new demographic reality. Labour markets in particular pose a risk of skill mismatch especially within traditional sectors as technological innovations and AI boost amplifies. Navigating such changes remains key for both governments and businesses in order to maintain the rapidly evolving consumer and labour markets of economies.

What could this mean for Sri Lanka?

Outside of dealing with the short-term implications of the current war, the changing economic landscape provides Sri Lanka with a mix of growth opportunities and challenges. The transition of the country from a deficit to a surplus economy itself places the country on a strong footing. As Sri Lanka continues on its recovery pathway while easing off its debt burden, in a context of rising global debt, it is highly likely that a possible credit rating upgrade will allow the country to regain access to global capital markets. Maintaining fiscal discipline on the other hand will allow the country to efficiently allocate resources towards social development and reform efforts. As reforms come into play and the private sector further expands its involvement in domestic economic expansion, the ability for the country to plug in to these newly emerging AI supply chains wouldn’t be a long shot. It also presents the country the opportunity to attract investments for the development of infrastructure and labour particularly for those outside of the traditional sectors. The key remains in how proactive policymakers are when it comes to accelerating reform efforts while maintaining broader economic recovery and how invested the private sector is to expand their game within a structurally different Sri Lankan economy in the midst of a rapidly evolving global landscape.

What drives the growth and what constrains it?

The recovery from slower growth in the second half of 2025 was propelled by the manufacturing sector, although the world’s second-largest economy continues to face pressure from declining property investment. Industrial production increased by 6.1%, with high-tech manufacturing standing out as a strong performer, growing by 12.5%. Manufacturing of products such as semiconductors, industrial robots, lithium batteries, and 3D printers performed particularly strongly, recording double-digit growth between 24% and 54%. Demand for manufactured goods was boosted by a 14.1% increase in exports during the first three months of 2026, according to earlier released data. In addition, fixed asset investment, which had contracted in the second half of 2025, increased by 1.7% in the first quarter.

However, China’s consumer services industry has been facing difficulties, with restaurants shutting down across the country and those that remain open often having noticeably empty dining areas. A prolonged and sharp decline in apartment prices has reduced Chinese household wealth, leading many consumers to rein in spending. Residential construction has slowed significantly over the past four years, but apartment sales have fallen at an even quicker pace, resulting in a rising surplus of unsold properties and making potential buyers hesitant to invest their savings in real estate. Meanwhile, retail sales grew by only 2.4% year-on-year in the first quarter and just 1.7% in March, falling well short of most economists’ expectations. Furthermore, car sales dropped by 17% over the quarter after the government reduced subsidies that had previously fuelled a surge in demand last year. Exports have supported the Chinese economy through much of its housing downturn since 2021. However, this time they were unable to offset wider weakness, following a sharp increase in China’s largest import category—computer chips.

What could risk China’s economic blossom moving forward?

China opened the year with stronger-than-expected growth, but analysts say this does not yet indicate resilience to the economic impact of the Iran war, which is clouding the global outlook and may still raise costs and weaken demand for the world’s second-largest economy. External demand helped sustain growth in the first quarter. However, this dependence also raises questions about how long it can last. Meanwhile, China’s factory-gate prices turned positive last month for the first time in more than three years, as surging commodity costs particularly oil—began to impact the country’s vast industrial sector. In recent years, major Chinese industries have been affected by excess capacity, leading to intense price competition and sustained deflationary pressure across the economy. According to data from the National Bureau of Statistics (NBS), the producer price index (PPI), which measures factory-gate inflation, rose 0.5% year-on-year, returning to positive territory for the first time since September 2022. Chinese policymakers have long sought to end deflation as they work to revive an economy burdened by oversupply and weak consumer demand. However, analysts caution that this “cost-push inflation,” driven by rising input costs rather than stronger demand, is not the ideal form of recovery. Instead, higher production costs passed on to already cautious consumers could further weigh on the economy by reducing household disposable income and dampening spending. Some economists caution that a prolonged Middle East conflict could drive up costs and squeeze producer profits, while also weakening consumer demand including from abroad, as rising prices reduce overall spending power.

China has traditionally depended on infrastructure development such as roads, bridges, ports, and other large-scale projects to stimulate its slowing economy. However, increasing debt levels, particularly among local and provincial authorities, are making this approach more difficult to maintain. Weak domestic demand has prompted Chinese firms to look overseas for growth. Exports rose in the first three months of this year at their fastest quarterly pace in over four years, driven mainly by electric vehicle and lithium battery shipments. Economists say these overseas sales have helped keep factories operating at high capacity across the country. However, the durability of this export strength remains uncertain. Tariffs and higher raw material costs linked to the Iran conflict appeared to weigh on the Chinese economy in March. Although China is relatively well positioned compared to other major economies to withstand disruptions to oil and gas supplies thanks to large fossil fuel reserves and its leadership in renewables, recent trade data points to unexpected changes that significantly narrowed its trade surplus. A key shift has been a sharp increase in semiconductor imports, despite a a weak Renminbi, as China rapidly expands data centre infrastructure to support artificial intelligence development. At the same time, exports of toys and footwear, once strong sectors—declined as rising plastic costs from the Middle East conflict squeezed manufacturers.

How will Sri Lanka be impacted from this?

As a key trading partner, Sri Lanka is likely to feel both direct and indirect effects from these developments in China. Slower and uneven Chinese growth could weaken demand for Sri Lankan exports such as tea, rubber, apparel inputs, and other commodities, while reduced Chinese outbound investment may delay infrastructure or development projects linked to Sri Lanka. The growing reluctance to spend amongst Chinese households, amid global uncertainties can also have an impact on Sri Lanka’s tourism sector.

At the same time, if Chinese manufacturers face higher costs and weaker global demand associated with the conflict in the Middle East, competition in export markets could intensify, placing pressure on Sri Lankan producers. Rising energy prices caused by Middle East tensions would also be significant for Sri Lanka, as a net fuel importer, increasing import costs, inflationary pressures, and pressure on the trade balance.

How will this change Sri Lanka’s macro-trajectory?

In January 2026, we spoke about Sri Lanka’s fiscal overperformance and external surpluses that would help reserve build up and put the country in a much better footing to absorb any shocks coming its way. Since then, the fundamental macroeconomic story has only gotten stronger outside the war with key domestic macro indicators showing continued positive momentum at the start of the year.

However, given the current situation in the middle east and its effects both on the global and domestic end, we do think there could be contained changes to our previous baseline.

The impacts of the Iran War will be large but with many counterweights as well

The obvious message is that an oil shock is negative onto Sri Lanka - as would a global military situation. Alongside oil, we take a closer look at other areas such as remittances, tourism, local and global demand conditions that could possibly take a hit while we also explore some of the ‘counterweights’ that tied to the current context which can go unnoticed since much of the focus is directed towards the clear negatives. It is really how these factors play against each other that will affect the way the war’s impacts play out onto Sri Lanka.

Three main scenarios amidst the fog of war

With all this uncertainty, we’ve gone through multiple scenarios on top of scenarios - but ultimately ended up on 3 key scenarios – as outlined in our Focus here.

What will the combined impact onto Sri Lanka be?

One way to understand this situation is through the lens of “The new Sri Lanka figuring out how a global conflict affects it”. Given the structurally different macroeconomic setting that Sri Lanka is right now, how domestic economic factors would evolve this time can be VERY different to how they did in the past - and that’s part of why we only think 80% of scenarios are covered through our thinking. Additionally, we recognize that there are other knock-on effects that can complicate this situation – stemming both from the local AND global front – that can take us beyond our 3-scenario expectations.

Right now, while we have put our views into these three scenarios, the developments over the next few weeks can change this. By the end of April, we think there will be enough clarity to rule out at least one of the three scenarios as a result, and we hope to be able to give clearer views at that point.

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Our clients would have already received a detailed report to their emails on this, alongside the numbers we associate with each of these varied scenarios. The full report has also been accessible on our Athena reports platform since the 31st of March, 2026. If you still haven’t had a chance to read through it, click here! If you are yet to be a subscriber, please do get in touch with us for a trial subscription to our reports at clientconnect@frontiergroup.info.

Disclaimer: Information collected/analyzed is from sources believed to be reliable or from the Central Bank/Government. Frontier Research Private Limited however does not warrant its completeness or accuracy. Opinions and estimates given constitute our judgment as of the date of the material and are subject to change without notice. The reports and presentations given are not intended as an offer or solicitation for the purchase or sale of any financial instrument. The reader must make their own independent decision regarding any securities or financial instruments mentioned herein. Securities or financial instruments mentioned may not be suitable to all investors. This communication including any attachments contained herein is governed and bound by the “Confidentiality and Disclaimer” detailed and available for your specific reference at our corporate website.

Right now, Frontier is working with three scenarios.

1. A Shorter War – This is a scenario where we envision de-escalation within less than a quarter. We think there have been historical occasions where conflicts in the Gulf region have seen high levels of escalation, only to find resolution after some form of a ceasefire. We think this remains a plausible path from here.

2. The Longer War – This is a scenario we think resembles the ongoing situation in Palestine and Lebanon, where conflicts persist without a clear or decisive resolution. Within a scenario like this, hostilities could drag on for an extended period, keeping pressure across global markets and supply chains elevated for much longer than most would anticipate.

3. The Sharper War – This is a scenario where significantly more parties become directly involved, resulting in a major, large-scale, all-out war. However, unlike the Longer War, this scenario may not necessarily persist over an extended period — the sheer intensity of the conflict could, in fact, accelerate its conclusion.

Across these three scenarios, we think the overall impact on both the global economy and the local economy could be broadly different in nature, magnitude, and duration.

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Our clients would have already received a detailed report to their emails on this, alongside the numbers we associate with each of these varied scenarios. The full report has also been accessible on our Athena reports platform since the 31st of March, 2026. If you still haven’t had a chance to read through it, click here! If you are yet to be a subscriber, please do get in touch with us for a trial subscription to our reports at clientconnect@frontiergroup.info.

Disclaimer: Information collected/analyzed is from sources believed to be reliable or from the Central Bank/Government. Frontier Research Private Limited however does not warrant its completeness or accuracy. Opinions and estimates given constitute our judgment as of the date of the material and are subject to change without notice. The reports and presentations given are not intended as an offer or solicitation for the purchase or sale of any financial instrument. The reader must make their own independent decision regarding any securities or financial instruments mentioned herein. Securities or financial instruments mentioned may not be suitable to all investors. This communication including any attachments contained herein is governed and bound by the “Confidentiality and Disclaimer” detailed and available for your specific reference at our corporate website.

What is at stake to completely reopen the Strait of Hormuz?

Since the February 28^th military attacks on Iran until the Strait of Hormuz (SOH) has been largely closed or severely restricted. This undoubtedly is impacting oil mobilisation therein affecting the supply. Monopolizing on the ultimatums US gives outs coupled with the importance of SOH, Iran has maintained selective, permission-based transit regime since early March. Essentially ships are approved to pass through the SOH on a case-by-case basis after communicating with extensive detail on the vessel ownership to the IRGC in advance. This unequivocally converts the SOH into a geopolitical tool of Iran who will continue to monopolize on the current geopolitical situation, exacerbated by Trump’s ultimatums and threats, while providing leverage to Iran’s allies such as China, Pakistan, India or Russia. Recently, Philippines secured access through the SOH. The ongoing trend shows that any country that is willing to side with Iran and show allegiance is likely to benefit by being given access through SOH, thereby securing oil supply and reducing impact on their local economy. It is likely that Iran continues on the status quo persists and takes control over who gets what and when relating to oil; more specifically isolating western-aligned shipping and rewarding allies.

This does begs the question as to how long Iran can keep up with the threats of US without obliterating their economy. Afterall US has a greater air force capacity than Iran, whose air force equipment are relatively less developed. Iran’s greatest strength regardless of infrastructure shortcoming li in their unconventional warfare methods such as cheap drones and sea mines and in part their geography. Both of these factors taken together makes it harder for the US or others to acquire SOH militarily. This, however, is not perpetual. As of now the US has destroyed most of the Iranian vessels, therefore the ability to enforce a blockade is shrinking due to depletion of physical assets. The next is the economic factor, which is the revenue streams to Iran which is already constrained due to sanctions. If oil exports of Iran (90% of total oil exports) through the Kharg Island is blocked, that would mean a recession level impact on the Iranian economy. All in all, the re-opening of the SOH appears to be contingent on significant resource depletion on the part of Iran and an economic downturn in the US with rising oil prices.

What could the continued rise in global energy prices mean for economies moving forward?

So far, we have seen Brent Crude oil price per barrel exceeding USD 100 and even reaching USD 126. If this selective closure persists, the situation can cloud economic progress and even create the perfect storm for recessions in countries like US and their allies. One way this is already impacting are fertiliser prices and availability as Urea prices have increased by 50% since the start of the war. This snowballs to overall increase in agriculture inputs with LNG disruption affecting planting season in the Northern hemisphere. This will undoubtably impact food prices towards latter part of 2026 and well into 2027. The macroeconomic impact will take flight through high inflation rates which will seep through into interest rates and markets in the long term. This can materialise to some extent regardless of the war ending, however, the recovery of this can be contingent on how soon the war ends. This is likely the greatest impact aside from energy disruption to the world. Secondary impacts include the cost to aviation by extension cargo and tourism. Surging jet fuel costs and closed Iranian and Iraqi airspaces has forced longer reroutes thereby increasing cost for the traveller and the airline therein. While this might not be a long-term impact, it is nonetheless a short-term impact that is causing disruption to countries that are determinant on imports, tourism and other sectors reliant on air travel.

All this points to a likelihood of economic downturns in certain countries. Already the International Energy Agency (IEA) chief has warned that April’s oil supply loss will be double that of March, as pre-war shipments dry up completely. Having already lost 12 million barrels per day the IEA head described this as the largest energy disruption in history, with rationing, inflation and growth slowdowns in emerging economies likely imminent. In the US, recession probability has surged across Wall Street, with Moody’s AI model sitting at 49%, while Goldman Sachs stands at 30% and EY Parthenon at 40%. The Federal Reserve is caught between cutting rates, risking inflation, or hiking. It is evident by now that the war does have a broad based impact from food to aviation to energy which can cumulate to an overall economic recession possibility. The recovery capacity will likely be determined on structural factors of economies such as fiscal stability coupled with structural enablers or barriers in relevant sectors.

How will Sri Lanka be impacted from this?

We are living through the impacts of interrupted oil supply, with rising oil prices to power outages. High cost air travel and shipping can largely impact tourism and exports. However, there are several mechanisms by which Sri Lanka reduces the dire impacts of this. First are the large fiscal buffers from tax revenue – they can act as a sponge to absorb some of the negative impacts of rising prices until and when the geopolitical tension eases. But it does not take away a complete impact of the war. Especially where remittances and tourism are a central source of revenue and foreign exchange to the country.

Second is the potential opportunity Sri Lanka’s Colombo port and even Hambantota port can be as a central point to trade routes instead of a purely transhipment route. This has a possibility given the efforts to expand the capacity via public and private partnerships. There has not been any materialisation of this in a large scale, but it is a possibility, nonetheless.

For decades, investors have treated it as the ultimate safe haven; the asset one relies on when everything else is falling apart. War breaks out? Buy gold. Inflation spikes? Buy gold. Dollar wobbles? Buy gold. When such conditions are absent, gold is of less importance.

That distinction matters enormously right now. The conditions that drove gold’s extraordinary 2025 rally have not just softened but also reversed. To understand why gold is falling now, one must understand how absurdly well it was doing just a moment ago.

Gold’s Big Run

The metal gained 64% in 2025, its strongest annual performance since 1979. The rally was well-founded at its origin: Central banks around the world were cutting rates, bond yields fell across multiple major economies and the dollar was declining. Gold was doing precisely what it was supposed to do under such conditions.

However, soon after gold had ceased to function as a monetary hedge and had begun to function as a momentum trade, not based on its intrinsic qualities but on the assumption that the favourable macroeconomic backdrop would persist indefinitely.

Gold entered 2026 at historically elevated price levels that had, by any conventional measure, already priced in a substantial degree of global risk. When an asset is priced for catastrophe and catastrophe duly arrives, the market reaction is often more muted than expected. The war in the Middle East is serious, but it was not, in a meaningful sense, a surprise to a market that had already spent a year pricing in geopolitical fragmentation. Put simply, gold may not be rising because it had already risen. While this may explain why gold prices have not risen, it does not explain the recent dip. Several factors need to be considered.

The Federal Reserve stalls rate cuts

At the start of 2026, financial markets were operating on a broadly optimistic assumption that the Federal Reserve would cut interest rates twice during the year. Gold is priced in US dollars, the Federal Reserve’s decisions carry a disproportionate weight in determining its global cost and appeal because gold is priced in dollars. When the Fed cuts rates, US bond yields fall and the dollar weakens both of which make gold cheaper for international buyers and less costly to hold relative to interest-bearing alternatives. No other central bank has such levels of influence on gold.

Then came February’s producer price index reading. It is one of the Fed’s early-warning signals for inflation. A reading of +0.7% meant that businesses were paying significantly more than expected, suggesting that inflation was not cooling as anticipated but was, in fact, re-accelerating. If inflation is still running hot, the Fed cannot justify cutting rates. So instead of two cuts, markets are now expecting just one. Some are questioning whether even that single cut would materialise.

The ten-year U.S. Treasury yield climbed back to 4.2%. Simultaneously, bold yields across major world economies also rose. Gold competes with bonds for capital, and when bonds offer more, the opportunity cost of holding gold rises. Institutional investors who had preferred gold because of the rate-cut found no more reason to hold onto gold and adjusted their positions accordingly.

The Dollar Strengthening

It’s hard not to see the irony in this case. The very forces generating anxiety in the Middle East along with the oil supply disruption have simultaneously strengthened the case for holding dollars. In such times, investors tend to seek safety in dollar-denominated assets, which pushes the currency higher. Add to that the prospect of interest rates staying elevated; this means dollar assets are offering better returns thereby becoming more attractive.

This creates a problem for gold. Since the metal is priced in dollars, a stronger currency makes it more expensive for buyers in Asia, Europe, and emerging markets. A Japanese investor or an Indian jeweller pays more in their local currency for the same ounce thereby reducing demand which in turn causes the price to fall. Gold’s safe-haven appeal and the dollar’s safe-haven appeal are, in this respect, in direct competition with each other.

The Oil Shock

The US-Israeli strikes on Iran in late February produced the kind of supply disruption that historically might have sent investors rushing into gold.

The disruption to Gulf oil supplies following the strikes on Iranian infrastructure sent crude prices sharply higher, feeding into the cost of transportation, manufacturing, and food across every major economy. This time around the oil shock has not merely raised prices in the near term, it has also raised the expected persistence of inflation across the global economy, giving central banks in the United States, Europe, and beyond additional justification for keeping monetary policy tighter for longer. The Bank of England cited energy costs explicitly in its most recent hold decision. The ECB flagged similar concerns. These decisions make interest-bearing assets more favourable than gold.

Leveraged Positions

When Iranian tensions first escalated, gold briefly spiked. Physical demand held firm, and premiums in the spot market remained high, suggesting that long-term buyers were not panicking. But the futures market behaved differently.

Leveraged speculators, like other investors, were also caught between a strengthening dollar, and a now hawkish Central Banks had little choice but to sell. Mostly because they needed cash to cover losses elsewhere, and gold was the most liquid asset they held. When they sold, the price dropped. When the price dropped this in turn forced more selling pushing the price further down.

What does this mean for Sri Lanka?

A falling gold price, measured in dollars, might seem like welcome relief for Sri Lankan buyers. But the rupee has weakened marginally against the dollar in the same period, which means that the price of gold in local currency terms has not fallen nearly as much as the international headlines suggest.

At the same time, Sri Lanka’s central bank, which has been carefully rebuilding its foreign reserves, holds a portion of those reserves in gold; a sustained decline in the golds value may put pressure on the reserve position.

For Sri Lankans who borrowed against gold jewellery a falling gold price can reduce the collateral value of those loans.

It is worth being precise about the nature of these risks, none of them are immediate, and most do not materialize unless gold prices continue falling over a sustained period. Pawnbrokers usually have buffers to absorb routine fluctuations, and the Central Bank’s reserve position remains strong. The concerns are likely to only materialize if the current sell-off proves to be the beginning of a prolonged structural decline rather than a cyclical correction.

The US-Israel war on Iran has now moved into its fourth week. Across these weeks, the fog of war has continued to be murky enough that it is both uncertain and volatile on what the future of the war is. However, one thing is clear enough. The conflict has lasted long enough and done enough damage, that it is now clear that the post-war environment will be markedly different from the pre-war context. As a result, we are now able to move into some clearer scenarios on what the future can be like and lay them out with clearer guidance on what that means for the Sri Lankan economy.

Our full note covers further details.

Clients with access to Frontier Athena can view the full report at athena.frontiergroup.info. For limited-time access, please contact us at research@frontier.info

The South Asian region has been recovering and has maintained its positive momentum in the past year. India was able to secure a favourable tariff deal with the US, Bangladesh successfully carried out its elections, Sri Lanka continued on its consistent path, recording twin surpluses, and Maldives saw a boom in tourism during the peak season. However, the region is now heavily impacted by the Middle East war, which brings both immediate and longer-term risks. The most immediate and obvious impact on the region is the rise in oil import costs. With crude oil prices at least 50% higher than pre-war levels, South Asian countries, which are primarily oil importers, will begin to feel the pressure. However, the impact of rising oil prices will be lower than in the past, as there has been an increase in solar power generation across the region, which can offset some of the price increases through a slight reduction in volume demand. Nevertheless, the overall impact remains negative, and countries have already resorted to measures such as for fuel rationing and increasing fuel prices. While the balance of payments impact can be managed for a few months using existing buffers, the immediate effect on inflation is more concerning. Although most countries in the region have recently recorded low inflation, Bangladesh is likely to be the most affected, as its inflation is already at elevated levels. The impact of the conflict goes beyond oil. A significant portion of worker remittances for the region, particularly for countries like Bangladesh, Pakistan, and Sri Lanka comes from the Middle East and has been a key source of foreign exchange inflows in recent times. While we do not expect an outright fall in remittances just yet, a prolonged conflict could slow migration and, in turn, reduce the growth of remittances from the region. Moreover, there is also an immediate impact on tourism earnings, particularly for countries like Maldives and Sri Lanka, as key travel routes may be disrupted during periods of escalation. Overall, we believe that the region could manage a conflict that remains escalated for a month or two using its existing buffers. However, a prolonged conflict could pose significant risks and potentially derail the current momentum the region has built over the past couple of years.

The full report covers further details, including:

1. Top 3 things you should know about the regional countries.

2. Summary of key economic indicators for the month.

3. Key news articles in detail,

Clients with access to Frontier Athena can view the full report at athena.frontiergroup.info. For limited-time access, please contact us at research@frontier.info

How have the conflict affected the global stock market?

Since USA’s initial attack on Iran with the “Operation Epic Fury” on 28^th February, Brent Oil Futures which were structurally at considerable low levels during 2025 and early 2026, climbed over 50% high as of last week’s closing price. The closure of the Strait of Hormuz has basically taken one fifth of global oil supply out of the system therefore, reducing global oil supply by an estimate of around 20 million barrels a day.

Apart from the direct effects of a decline in oil and gas, which then affects global trade and freight, creating a second wave of various economic complications, future outlook on oil prices and supply along with the overall escalated conflict of the region is also weighing on the decision of global investors. From the time of the initial attack, Dow Jones has fallen around 7%, S&P 500 by around 5.5% and NASDAQ by 4.5% over the past 3 weeks. Apart from US stocks, here’s how other major global indices have fared as of Friday the 20^th March.

o Shanghai Composite Index fallen by 5%

o Japan Nikkei 225 index fallen by 9%

o India’s Nifty50 fallen by 8%

o Hong Kong’s Hang Seng Index fallen by 5%

o London’s FTSE 100 fallen by 9%

o Europe’s STOXX 600 fallen by 10%

o Australia’s ASX fallen by 8%

With regard to the outlook on global stock markets, strategists from Goldman Sachs Group Inc., Morgan Stanley and JPMorgan Chase & Co. point to case for US stocks to remain intact despite risks posed by the war with Morgan Stanley forecasting bigger negative impact on European and Asian economies due to its higher exposure to fuel costs while U.S. equities could stay relatively less impacted helped by strong energy-sector performance and with global investors shifting to “safer” U.S. assets. At the same time, CGS international said a prolonged war could prompt a 10%-15% contraction in global stocks. overall, there seems to be a conflict in consensus regarding how stock markets would be affected in the short-medium term given the uncertainty on the duration of the conflict and its ramifications.

How are Central Banks reacting to the conflict?

The past week was a decisive week for most central banks, with their scheduled monetary policy decisions. The consensus among most economists prior to February 28^th were for most central banks to go for rate cuts given the falling inflation expectation and weakening job market. However, with volatile global energy prices reigniting inflation fears among most countries, the Bank of England, U.S.’s Federal Reserves, the Bank of Japan along with the Bank of Canada all decided to maintain current rates citing middle east uncertainty. Economists argue that energy price hikes are far more dangerous unlike wage-push inflation which can be balanced by increased productivity. Energy inflation would bring about a cascading effect by raising the cost of production, logistics and transport which could have a longer-term impact to inflation.

Against this backdrop, government bond yields from Britain to Italy and the United States have also experienced a considerable volatility over the past three weeks as a chain reaction from heightened inflation pressure. According to The Guardian, UK’s bond yield have surged to their highest levels since 2008 with growing weight for the BoE to raise rates up to three rates this year while CME FedWatch has increased the probability for the U.S. Federal Reserves to raise benchmark rates by at least 25 bps.

What’s going on with gold and what does USD have to do with this?

Gold, typically seen as a safe-haven at times of global uncertainties is behaving in a contrarian manner with prices recording strong downturns. Prior to the Middles East conflict, Gold surged above $5,300 an ounce extending historic rally as economic and geopolitical uncertainties together with weakened confidence in the U.S. dollar in the early months of 2026. However, with Iran-Israel U.S. war, the prices of gold and other precious metals started a sharp fall despite increased market and geopolitical uncertainties. As of last Friday, Gold Spot fell by nearly 19% with gold trading lower than before the war began.

Two specific factors point to this. One being the relatively stronger U.S. Dollar from before the war began. In fact, the dollar has strengthened against all major currencies, once against regaining its place as a safe-haven asset on the back of oil price surge, which are priced in dollars. Given that relative strength of the U.S. Dollars, it now becomes more expensive for international buyers using other currencies to purchase Gold. Due to this, demand from those buyers have declined considerably and has pushed prices down. At the same time, with rising oil prices driving up global inflation, it becomes more difficult for Central Banks and monetary policy decision makers to go for rate cuts. With investors expecting rates to climb higher than its current levels, gold becomes less attractive due to the lack of an interest return while investments can offer high return especially with the possibility of higher rates becoming more than possible than before.

What the global market reaction to the ME conflict could mean for Sri Lanka?

While Frontier Research has put out few reports on the direct economic implications of the ME conflict to the country’s economy, global market reactions to the situation could also have a number of effects to the economy. Starting off with a relatively stronger USD which could mean some depreciation pressure for emerging market currencies including the LKR and thereby a double shock to the oil bill in addition to the already higher oil prices. CT Smith also warns that potential uptick in inflation could limit the likelihood of a Central Bank policy rate reduction in the near term just as for most global central banks. The Sri Lankan stock market has also reacted and remained quite bearish to the ME conflict with over Rs. 1 trillion being wiped off from the Colombo Stock Market since the conflict began according to Ada Derana.

Sri Lanka’s financial markets have been experiencing modest pressure following the outbreak of Operation Epic Fury in the Gulf region roughly two weeks ago. Despite significant military exchanges and shipping disruptions driving oil prices past USD 100 per barrel, the Sri Lankan rupee has depreciated by only about 0.56%, slightly less than the 0.7% seen during a comparable 12-day conflict last year. This as a relatively contained reaction, particularly if the conflict proves to be short-lived.

A key reason for this resilience is the strong external position Sri Lanka enjoys. Inflation is also expected to remain manageable given that it had been running well below the CBSL’s 5% target prior to the conflict and any upward movement here could be contained.

The topline message for now is that if things do turn quite rapidly as we suggested in our full note, oil prices could snap back pretty quickly too. Alongside that, other fundamental factors encouraging a significant rebound indicate that if resolution comes faster and more decisively than expected, do not rule out a fairly sharp easing on both fronts. In a baseline scenario any costs can be absorbed as well, and in a case where there are costs outside the baseline scenario, we don’t think those will be existential given the strength of the buffers we have outlined.

Our full note covers further details.

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As markets are pricing the heightened risk on oil, other commodities and capital flows, this week we find ourselves in a position where few major central banks are also to make their interest rate calls suggesting their outlook on the current context and how they see it impacting domestic economies. Policymakers are expected to price in the disruptions in global supply chains and the consequences to the domestic economy on one hand while factoring in the inflationary expectations that are building up as the war progresses on the other. Will they cut rates with the intention of giving a slight push to the domestic front? Will they hike to counter the expectations around inflation? Or, will they stay put and take a ‘wait and see’ stance? – questions that we’ll have answers to in the upcoming week.

Inflation signals, Job market and the Trump factor

The US Federal Reserve (FED) has maintained a cautious stance during recent months factoring in the inflation trends, labour market developments and risk conditions. At its first meeting of 2026, the US central bank left borrowing costs unchanged, following three consecutive rate cuts implemented late last year. Latest data on labour market front – The Bureau of Labour Statistics earlier this month reported that employers shed 92,000 positions in February as the unemployment rate rose to 4.4% from 4.3% - suggest that a rate cut seems to be on the cards to give a little boost to the slowing domestic economy. There is also the political push coming from the president who has repeatedly advocated for a cut. President Donald Trump demanded last Thursday that the Federal Reserve cut interest rates “immediately,” criticizing Jerome Powell for waiting until the central bank’s next policy meeting.

However, heightened inflation has been a key factor for the FED to not act out immediately. Price increases have remained stubbornly above the FED’s target rate of 2% with the latest data for February indicating 2.4% even BEFORE the Middle Eastern tensions came in to the picture. With visible effects of how US consumers and businesses are feeling the inflationary effects of the war now, analysts are pushing back the possibility of a rate cut to June 2026. The Federal Open Market Committee (FOMC) is expected to announce the next move on Wednesday (March 18^th).

ECB facing the Eurozone test

While market expectations about a rate cut have drastically shifted since the war, whether or not the European Central Bank (ECB) may hike or keep rates unchanged is the conversation going on now. As a region heavily dependent on imported oil and natural gas, surging oil and gas prices has triggered an inflation shock for the ECB. The bank’s decision to resist despite market pressure to raise rates back in 2022 when Russia invaded Ukraine, did not serve the region well and could be a major driver of the rate call this time.

Growth expectations are also revised down with inflationary expectations picking up on the back of rising energy prices. Particularly on Germany, where economists predict a slowdown in growth as tensions continue which could impact the overall growth story of the eurozone. Yes, how long would the war last is a decisive factor to be considered here and a question that no one can give a proper answer to as of yet. What is certain however, is that the ECB is more likely to act faster this time in countering inflationary expectations at an early stage than in 2022.

Bank of England (BOE) also find themselves at a similar spot where expectations have reversed in a matter of days. Just two weeks ago, investors anticipated two quarter-point cuts in 2026, with the first coming as soon as the BoE’s meeting next Thursday. However, given the rising oil prices within the last few days with no signs of the war easing, investors are now betting on the BOE to raise borrowing rates.

Rate decisions across the rest of the world

Similarly, other major global central banks, including all members of the Group of Seven and those representing eight of the world’s ten most-traded currencies, are expected to signal to investors that the risk of a renewed inflation shock is significant enough to warrant a more cautious approach to monetary policy.

For instance. Japan, which relies quite heavily on imported fuel and food could face heavy stress if higher oil prices persist. Furthermore, prolonged weakness of the Yen – which fell on Friday to its lowest level against the dollar since 2024 - could also be a major concern that could quickly translate to domestic inflation and therefore a key area of focus in its interest rate decision.

Bank of Canada, Swiss National Bank, Reserve Bank of Australia, Swedish Central Bank and many other monetary authorities across the East and West are to re-visit their outlooks in the coming week.

What does this mean for Sri Lanka?

The most obvious point for Sri Lanka would be to see how global players are factoring in the possibility of the war being dragged on or not. If authorities are expecting a more prolonged ‘forever in war’ kind of scenario or if they expect this to be more short-lived with massive spikes in oil and other commodities in either way – up or down. As uncertainty, heightened energy prices and rising inflationary expectations are priced in, how investors move from there onwards will be key to look out for. While Sri Lanka’s relatively stable macroeconomic footing to face such crises unlike in previous episodes could present an opportunity to attract investors moving out of the Middle-Eastern region, a prolonged version of disrupted oil supplies undoubtedly, could cause serious damage which may alter the economic narrative both on the global and local front, for reasons beyond our control.

This Week’s Developments

The past week marked a sharp escalation in the conflict, as the United States carried out its largest bombing campaign to date against Iranian military infrastructure in Tehran and Isfahan, prompting retaliatory missile and drone strikes on US bases in Iraq and Syria as well as Israeli cities including Tel Aviv and Haifa. Iran’s response spilled further into the region, with Gulf states such as Dubai, Abu Dhabi, Qatar, Kuwait, and Bahrain hit by drone incursions and missile attacks on strategic infrastructure, such as oil production facilities and airports.

Against this backdrop, President Donald Trump declared that Washington’s objectives extend beyond military action to shaping Iran’s political succession, rejecting the candidacy of Ayatollah Khamenei’s son, Mojtaba, and insisting the United States must be directly involved in deciding the country’s next leader. In contrast, Iranian President Masoud Pezeshkian sought to reassure neighbouring states by announcing that Iran would halt further strikes on Gulf countries, stressing that operations would remain focused on US and Israeli targets unless Gulf territory was used to launch or support attacks against Iran.

What could this mean for the global economy and trade?

The energy shock was the most immediate and visible consequence of the week’s developments. Brent crude’s climb above $93 per barrel marked its highest level in months, driven by fears of supply disruption through the Strait of Hormuz. With nearly one‑fifth of global petroleum shipments passing through this narrow waterway, the withdrawal of insurance coverage for tankers effectively froze traffic, forcing refiners in Asia and Europe to scramble for alternative supplies. In the United States, gasoline prices jumped by more than 10% in a matter of days, adding pressure on households already grappling with elevated living costs. The surge in fuel prices also fed into broader inflationary expectations, with analysts warning that higher transport and production costs could ripple across consumer goods and services worldwide.

Financial markets reflected the turbulence with sharp swings. The Dow Jones Industrial Average fell nearly 800 points mid‑week, erasing billions in market value and underscoring investor anxiety. European and Asian indices also registered losses, though oil majors and energy‑linked stocks gained ground as investors sought refuge in sectors poised to benefit from higher crude prices. Safe‑haven assets surged: gold climbed to multi‑month highs, while currencies such as the Swiss franc and Japanese yen strengthened against the dollar. Emerging market currencies, particularly those of oil‑importing economies, came under pressure as rising import bills threatened to widen current account deficits and weaken exchange rates.

Shipping and logistics were equally strained. With tanker traffic through Hormuz curtailed, freight costs surged as vessels were forced to take longer routes. Container shipping faced delays, disrupting supply chains for goods ranging from electronics to agricultural commodities. Insurance premiums for vessels operating in the region spiked, adding further costs to global trade. The paralysis of one of the world’s most critical maritime chokepoints underscored the vulnerability of supply chains to geopolitical shocks, raising concerns about the resilience of global commerce.

How will Sri Lanka be impacted from this?

Sri Lanka found itself unexpectedly in the spotlight as two Iranian naval vessels became entwined with the unfolding conflict. The first, an Iranian warship, was sunk off Sri Lanka’s southern waters near Galle during US led strikes, with dozens of sailors killed and survivors rescued by the Sri Lankan navy. Just days later, a second Iranian vessel docked in Colombo, carrying more than 200 crew members, including cadets and senior officers. These incidents placed Colombo at the edge of the battlefield, raising both humanitarian and diplomatic challenges as the country coordinated recovery operations while avoiding deeper entanglement in the war.

The government has already warned of fuel and gas price hikes, as disruptions in the Strait of Hormuz threaten to choke supply lines and push up import costs. For a nation heavily reliant on imported petroleum and cooking gas, even modest increases tend to translate quickly into inflationary pressures, for instance, via higher transport fares and electricity bills. The tourism sector, a vital source of foreign exchange, is also under pressure. Airlines have begun rerouting flights to avoid conflict zones, which lengthens travel times and raises ticket prices. These higher costs, combined with global traveler caution, may have led to cancellations and reduced arrivals in Sri Lanka.

With increasingly powerful models and agents at our disposal, the use of AI-powered solutions has also gone up by leaps and bounds. This AI transition is one of the two major technological transitions taking place in the modern world with the other being the sweeping shift to renewable energy sources, particularly solar energy.

Nearly 75% of this capex spending is utilized for AI infrastructure and a significant portion of this is focused on hardware components, data center infrastructure, networking and auxiliary systems. Presently, demand for AI specialized hardware substantially outpaces supply. This structural shift in capital allocation toward hyperscale computing by large hyperscaling companies are also causing second-tier players ramping up cloud capacity to remain relevant.

The AI capex boom has consequently pressurized related commodity prices upwards. Industrial metals and other less obvious materials like silver used in electrical infrastructure are seeing rising demand tied to AI data centres. This demand is only set to increase as power architectures evolve toward higher-voltage systems.

Leading AI firms have seen their valuations climb sharply. Subsequently, investors expect huge payoffs in the short term which now seem increasingly uncertain as some argue the gap between investment expenditure and the actual expectations for future profits have become increasingly wide, as seen by AI revenue falling tremendously short of expectations.

However, there are also reasons to believe that this cycle may differ from past episodes of over-investment. Unlike earlier technological booms, AI is already being deployed at scale across a wide range of industries, with immediate applications, suggesting that at least a portion of the anticipated value is already actualized rather than being purely speculative.

Since we first sent out our Quick Update on the ongoing military conflict in the Middle East, the situation has continued to be quite volatile. Most events since then have been in the direction of escalation, but with enough events that also point towards a quicker resolution being possible. Probably the most alarming of these have been how much oil prices have risen - over USD 100 per barrel on Monday open. The overall situation is simply volatile and it might be near a moment of maximum uncertainty about how this can play out.

With varied reports continuously suggesting increased escalation in the Gulf, how can this moment of uncertainty resolve?

In our previous update, we put forth three broad scenarios.

1. In our first scenario, the conflict lasts for a few weeks at a heightened level but then resolves quickly - before the month is over.

2. In our second scenario, the conflict escalates into a protracted war that lasts for a few months between the primary belligerents - US, Israel, Iran - with others drawn in occasionally.

3. In our third scenario, we had a full-blown regional war that lasts for many months.

In the first few weeks, all three scenarios will look very similar - rapid escalation including strikes outside the main belligerents. Only after this does this clarify towards a resolution, a protracted conflict, or a full-blown regional war.

The way we understand this right now, in any case, these conflicts do remain for an extended period. For Sri Lanka, macroeconomically, this would mean there is a definite ‘shock scenario,’ but given the underlying strength the country has achieved through fiscal and external buffers, it could be an “interruption” to the broader Sri Lankan economic story that has been building up — and the larger the shock, the greater the interruption. Over the next few days, we expect to be conducting far more detailed work on this, particularly given the potential for even a temporary rise in oil prices to have knock-on effects across global financial markets. Should the more adverse scenario of a wider and more protracted war materialise, we will continue to expand our work over the coming weeks in this direction, with the aim of helping clients understand, plan, and navigate what is likely to be an extremely uncertain and challenging operational environment.

At the end of the previous week, Israel and the US launched a military intervention in Iran. In response, Iran retaliated with strikes across US and Israeli targets in the region. Airspace across parts of the Middle East was temporarily closed and has since reopened, while all sides are signaling a continuation of hostilities. We are not military experts by any means. In fact, military forecasting probably has an even worse track record than economic forecasting. With that in mind, this update outlines our initial thinking on how the broader trajectory of military conflict in the Middle East could evolve and how it may affect the Sri Lankan economy.

The key message is that this is undoubtedly a delicate global moment geopolitically. It creates space for greater regional confrontation than before, with the risk of spillovers across the Middle East. Countries located between Iran and Israel are already experiencing indirect damage due to these tensions.

The full Quick Update contains our views on the economic impacts of the ongoing attacks, our broad scenario mapping and corresponding oil price implications as well as the implication on the Sri Lankan economy.

Clients with access to Frontier Athena can view the full report at athena.frontiergroup.info. For limited-time access, please contact us at research@frontier.info

Overall budget and primary balances record historic balances in 2025

In 2025, Sri Lanka recorded its lowest ever budget deficit in decades of around -2.2% of GDP. For an economy that has seen budget deficits of at least 5% even in a good fiscal year, and deficits even surpassing 10% of GDP in some years (2020–2022), this current performance is by far one of the best turnarounds any economy could have seen.

Adding to this is the primary balance of the budget, expected to be around 5.5% of GDP In 2025 - more than double the IMF’s and the initial budgeted estimate of 2.3% of GDP. This marks the third consecutive year of primary surpluses, a mark that the Sri Lankan government has never achieved before. All of this overperformance stems from varying factors including improved revenue collection and contained government expenditure.

Government revenue has been quite strong

Sri Lanka’s revenue overperformance has drawn considerable attention and has been talked about somewhat favorably in recent times and has even been commended by the IMF. From historic lows of around 8% of GDP a few years ago, the government has now been able to collect close to 17% of GDP in total revenue including grants in 2025.

Income taxes continued to grow beyond nominal GDP growth

The Budget for 2025 announced a widening of the tax-free threshold for income taxes, increasing it from LKR 100,000 to LKR 150,000. This was initially identified as a factor that could cause income tax collections for the year to fall, as some individuals would now be exempt from paying. However, despite this widening, income tax collections for both corporate and personal taxes rose and contributed positively during the year.

Indirect taxes on domestic goods have continued to improve along with growing economic activity

The overall pickup in economic activity, driven by higher private sector credit, also meant that in 2025 indirect tax collections started to pick up. Higher VAT rates, the lowering of the VAT threshold, and the removal of exemptions over the last couple of years have all contributed to this increase.

While revenue collections overperformed, government expenditure remained broadly contained

Overall, government expenditure in 2025, despite rising marginally in nominal terms fell as a percentage of GDP when compared to the previous year. This fall in government expenditure mainly comes from a reduction in recurrent spending, which was partly offset by a marginal rise in capital expenditure during the year.

Expenditure on salaries remained largely flat while transfer spending fell in 2025

The NPP government that came into power in late 2024 fulfilled part of its election promise by increasing public sector salaries in its very first budget, with implementation expected in several stages starting from 2025. As a result, while one would have expected salary-related expenditure to rise by a significant margin, as most public sector salary revisions usually do, it only rose marginally in nominal terms and potentially would have fallen as a percentage of GDP.

The fall in interest payments was a key driver in bringing overall expenditure down

As a result of improved fiscal performance in 2023 and 2024 the government’s deficit financing needs were much lower in 2025. Furthermore, the cash buffers built by the government as a result of primary surpluses meant that the government was able to pay down some of its outstanding debt, particularly short-term treasury bills.

Can this be sustained going forward?

Sri Lanka has now seen three consecutive years of primary surpluses and has consistently overperformed on set targets, with each year doing better than the previous one. The key question now remains whether Sri Lanka can sustain this fiscal overperformance going forward.

All in all, real story of 2025 is not merely that targets were exceeded, but fiscal measures taken post crisis has started to bear fruit and now look sustainable. Moving from crisis management to surplus generation in three years is no small feat for any economy. Whether this pace can be maintained remains to be seen, but for now, the numbers are cooperating, the Treasury is breathing easier, and a “fiscal surprise” no longer means that the deficit was larger than expected, but the opposite.

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The strength of Sri Lanka’s overperformance is worth repeating. Twin surpluses – the countries’ primary fiscal and external current account surpluses - have continuously overperformed forecasts made by the IMF and proved to be quite positive. This is a superlative performance by any means, and we have explored in multiple reports across the last years why this was the case.

Revenue growth has been broad-based and rising faster than economic activity. Both Recurrent and Capital expenditure have been contained due to structural issues and capacity constraints. Remittances, tourism, port services are all adding significant FX inflows. All of these factors have combined to pose a stronger primary and current account in 2025 than in 2024!

In many ways, we think this strength itself is moving almost “too fast” for markets to react. Given that Sri Lanka is under an IMF program, with a high stock of debt, and given our history with policy failure, it is probably fair for the IMF or other international agencies to not be too optimistic at least at the starting point of engaging with Sri Lanka.

However, as more and more data come through out of the system, we think more and more of the international institutional forecasts also start to reflect Sri Lanka’s actual economic overperformance. In such a context, we think it will impact both the domestic and the global market narrative about Sri Lanka, making it much easier for participants to act on the fundamental story.

We also feel that there are enough pressures that prevent the kind of rapid action that might be needed to fully capitalize on this economic turnaround.

The first set of pressures are the existing uncertainties about the Sri Lankan economy itself. While the scale of change is at a different level altogether, the worry that Sri Lanka will somehow find a way to shoot itself in the foot once again exists. Even if this doesn’t occur, the lack of further reform right now can also make both belief in the situation, and critically, ability to act on the situation harder.

On top of everything going on locally, there are also three big global shifts that once again add uncertainty and make larger actions feel risky. Global trade tensions continue to be elevated, geopolitical concerns are looming high, and techno-social impacts of AI adoption are all leading to a situation where forecasting the global economy is becoming increasingly hard.

However, for most contexts we think the way forward will be much clearer as more of the macroeconomic strength comes through into the data and sentiment shifts do take place both locally and globally, thereby resulting in a shift from the current cautious optimism to one of more jubilance.

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What has happened so far?

Whilst the US and Israel continue to justify the war with Iran as a pre-emptive measure, the lack of an imminent threat to rationalize this stance inevitably makes this a war of choice. The socio-political unrest within Iran and the freefall of its economy due to crippling sanctions along with the weakened defenses after the scuffle with Israel has made the nation vulnerable, an opportunity to exploit. The objective of this war, according to the White House is to ‘ensure that Iran does not obtain a nuclear weapon’ and ‘dismantle the Iranian regime’s security apparatus, prioritizing locations that posed an imminent threat’. On the contrary, Iran has repeatedly said its nuclear activities are entirely peaceful. The attacks began at a time when the United States and Iran planned to resume negotiations after consulting their capitals with technical discussions expected to take place during the first week of March after constructive progress was achieved in talks between both nations pertaining to Tehran’s nuclear program in Geneva, though no breakthrough was achieved.

At the present moment, Iran continues to retaliate by attacking Israel and US bases in the region after the killing of the Supreme Leader and around 40 top Iranian officials. Gulf nations affected thus far by attacks from either Iran or Israel include Bahrain, Iraq, Jordan, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates and most recently Lebanon. Currently, there seems to be no cessation in sight.

The Global Economic Impact

The Strait of Hormuz through which one-fifth of the global oil and LNG shipments travel through from the Middle East mainly towards Asia has unsurprisingly caused anxiety within markets since a complete shutdown of the narrow chokepoint by Iran is well within the realm of possibilities which could result in oil prices surpassing the $100 per barrel mark. However, a more likely scenario is the halting of oil purchase from Iran which could hurt its already shattered markets. This may result in oil prices reaching as high as $80 per barrel. Though Iran supplies oil to China, its production is not critical to global oil consumption as it makes up only less than 3% of the global supply. Presently, given the excess supply of oil available in the global market, apart from the initial spike seen immediately after the attacks in isn’t any short-term pressure for the prices to increase, though a prolonged conflict may result in prices reaching as high as the two scenarios mentioned above. Simultaneously, safe haven assets are expected to move upwards as they usually would during periods of turmoil. The bullish run by gold and silver in 2025 along with safe currencies such as the Swiss Franc can be expected to continue as investors seek to protect their wealth, though once again the extent of this upward trajectory also hinges on the duration of the conflict. Additionally shipping markets have also been disrupted, with tanker movements curtailed and insurance costs rising steeply, further tightening global supply chains.

Economics around the world may experience some degree of increased macroeconomic stress. Sharp spikes in global energy prices have the potential to raise input costs for manufacturers and households alike, feeding into broader inflationary pressures that central banks in the United States, Europe, and Japan may be reluctant to ignore. Higher fuel and transportation costs risk slowing consumer spending and business investment, potentially dampening already fragile growth prospects. Emerging markets in particular may end up bearing the brunt of the financial fallout, as currencies weaken in response to higher oil import costs and capital outflows. Oil-sensitive economies, particularly in Asia and parts of Africa, are experiencing heightened volatility, while Gulf economies face a dual shock of financial outflows and elevated geopolitical risk despite currency pegs.

The global financial markets are undoubtedly experiencing a turbulent period. Recently markets saw steep sell-offs as fears of AI-related disruption towards major businesses continue to threaten investors. In the US alone, this fear has translated to a decline in the Nasdaq Composite (a major stock market index that focuses primarily on tech stocks) by more than 3% in February. The new Iran conflict, the latest blow to the markets can be expected to turn indexes red and keep risk-appetite low, particularly until the trajectory and duration of the conflict can be gauged.

The South Asian Impact

With millions of migrant workers from India, Pakistan, Bangladesh, and Sri Lanka employed across Gulf economies, disruptions caused by retaliatory strikes and infrastructure damage, particularly in central locations such as Abu Dhabi, have already resulted in casualties and raised the possibility of large-scale evacuations. This poses a direct threat to remittance inflows, which are critical for South Asia as they make up a substantial share of GDP in countries like Nepal and Pakistan. A prolonged disruption risks triggering balance-of-payments stress, particularly for smaller and more vulnerable economies.

Higher crude prices are increasing import bills across South Asia, weakening exchange rates and weakening current account positions, while also feeding into domestic inflation through higher fuel and transport costs. At the same time, logistical disruptions from restricted airspace over Iran and the Gulf are increasing transportation and freight costs thereby obstructing export operations. For economies reliant on energy imports and external demand, these developments represent a significant downside risk particularly if the conflict prolongs.

South Asia has got off to a positive start in 2026, despite risks still remaining. A major highlight during the past month was the trade deals signed by countries in the region and increasing bilateral relationships, along with the elections in Bangladesh. Overall, the region has seen improving fiscal and external conditions, though at different levels for each nation.

During the past month, India got off to a good start by securing a much-needed trade deal with the US, lowering tariffs to 18% compared to the higher rates of 25% imposed earlier. While this can create some space for exports to the US to further grow compared to last year, given the comparable tariff rates across other competitive nations in the region, the higher prices could still damper US demand for Indian exports to some extent. On the other hand, India also finalized its long-standing trade deal with the EU, which could create more opportunities in the years to come. However, something to note is that most trade deals signed by South Asian nations have created some noise at the beginning but have later failed to materialize and reap full benefits as expected.

Bangladesh, on the other hand, has finally seen through its long-awaited elections post the Sheikh Hasina era, and the newly appointed party would ideally intend to bring much more stability to the nation. Along with this, Bangladesh has also been able to marginally lower its US tariff rates further, while providing preferential access to the US in Bangladesh markets. Adding to the positives is the continuous improvement in remittance inflows to the country, which is helping stabilize the balance of payments current account, despite inflation being slightly higher than anticipated.

The Maldives and Sri Lanka continue to record high tourism inflows during the peak season right now, and it is helping the countries’ foreign inflows. Foreign reserves in both nations, despite not being at their highest, have marginally risen, giving some stability on the external front. Further, Sri Lanka is seeing a significant increase in private sector credit-led growth while maintaining twin surpluses for the third consecutive year now.

Overall, the start of 2026 has broadly remained positive for the region, despite underlying challenges of high debt and climate-related risks still remaining. However, the positive momentum could potentially create a buffer to act against any shocks that could materialize if they do.

The full report covers further details, including:

1. Top 3 things you should know about the regional countries.

2. Summary of key economic indicators for the month.

3. Key news articles in detail,

Clients with access to Frontier Athena can view the full report at athena.frontiergroup.info. For limited-time access, please contact us at research@frontier.info

However, on 20^th February 2026, the US Supreme Court ruled by a 6-3 majority against President Donald Trump’s reciprocal tariffs, holding that the International Emergency Economic Powers Act (IEEPA) did not grant the authority he claimed to impose such measures. In response, Trump described the decision as deeply disappointing and announced plans to replace the invalidated measures with a global duty initially set at 10%, which was subsequently increased to 15% under alternative legal authority.

What could this mean for the global economy and trade?

Broadly, these developments could mean that volatility in the global trading system is likely to continue, with several implications for the global economy as well. While the US Supreme Court ruling provides some reassurance to trading partners regarding the limits of the unilateral executive action, President Trump’s rapid replacement of the struck-down tariffs with a 15% global duty under an alternative legal authority signals that policy uncertainty could remain a central concern for all stakeholders.

The ruling also raises potential long term complications for businesses and importers as it did not clarify how the refunds for tariffs already paid should be handled. Recovery of these duties could possibly take several years, leading to prolonged uncertainty and creating a complex legal environment for international trade.

For global trade more broadly, the reinstated tariffs could slow the flow of goods, increase costs for importers and consumers and lead to some sort of supply chain interruptions particularly for export-dependent economies such as China, India and other major US trading partners. Uncertainty over which trade agreements will survive under the new tariff framework may discourage potential investments and long-term strategic planning, while the risk of reciprocal measures or similar unilateral actions by other countries could further undermine the multilateral trading system and fragment global trade networks. Overall, these developments could mean a possible shift away from predictable, rules-based trade toward a more uncertain global environment, with possible negative consequences for economic growth, stability and international cooperation.

How will Sri Lanka be impacted from this?

For Sri Lanka, the US tariff situation carries very direct economic implications as the United States is one of the country’s largest export markets, particularly for garments and textiles. Sri Lankan exporters had previously secured a 20% tariff rate on apparel exports to the US, down from steep reciprocal duties earlier proposed under Trump’s original tariff regime which was seen as a critical concession to maintain competitiveness against regional rivals like Vietnam and Bangladesh.

However, recent developments have disrupted the previously negotiated framework, placing Sri Lankan exporters in an uncertain position. Without a secured bilateral trade deal, Sri Lanka remains sensitive to such unilateral shifts in US policy, as uncertainty over tariff rates could complicate pricing decisions and long‑term contracts with US buyers, who make up for a significant share of Sri Lanka’s export volume. As a result, the current situation highlights the importance of strategic diversification and stronger trade agreements to mitigate the impact of continued US tariff volatility on Sri Lanka’s apparel sector which is a key driver of foreign exchange earnings and employment.