How Middle East instability will shape Government finances post-2026

2026-05-26 1247

(Cathrine Weerakkody)

By 2026 and beyond, the fiscal fortunes of governments across the Middle East and North Africa will be increasingly inseparable from the region’s security environment. This is not a distant hypothetical. The transmission channels are already visible, and the consequences for public finances, sovereign debt, and economic stability are well understood. Sri Lanka, which declared external default in April 2022, offers an uncomfortable but instructive reference point.

Four channels matter most: tourism revenues, remittance flows, export earnings, and banking sector liquidity. Each is sensitive to instability in its own right. Together, they are capable of triggering a fiscal deterioration far faster than most governments plan for.

Tourism income

Tourism is the most volatile of the four. For Egypt, Jordan, Lebanon, and the UAE, international arrivals generate hotel taxes, VAT receipts, and foreign currency that feed directly into government revenues. Egypt is particularly exposed: according to World Travel and Tourism Council estimates, the sector accounts for roughly 8 to 9% of GDP, and tourism receipts reached around $15 billion in 2024. Sri Lanka earned approximately $4.4 billion annually from tourism at its 2018 peak. When the Easter Sunday attacks of 2019 and then the pandemic combined to collapse arrivals, foreign reserves fell sharply and the Government lost a critical source of hard currency. A comparable shock to a Middle Eastern economy with similarly thin reserve buffers could produce the same trajectory.

Remittances are less visible in fiscal accounting but equally consequential. Transfers from Gulf Cooperation Council workers to Egypt, Jordan, and Lebanon support household consumption and, through it, VAT collection. If Gulf economies slow or guest worker policies tighten, those flows contract. Sri Lanka’s remittances peaked at around $7 billion in 2016 and 2017 before declining in subsequent years; by 2022, inflows had fallen to approximately $3.8 billion, partly because currency controls made formal channels unattractive and pushed transfers into informal routes. For a country already carrying a heavy debt burden, that shortfall was not manageable through adjustment alone. Middle Eastern governments that rely heavily on remittance-supported consumption face an analogous vulnerability.

Trade and export earnings introduce a third dimension. Any sustained threat to the Red Sea or the Strait of Hormuz raises shipping costs and disrupts trade finance, affecting Suez Canal revenues for Egypt, logistics for Gulf states, and re-export income for the UAE. Sri Lanka’s experience in 2022 illustrates how quickly a trade finance collapse becomes a domestic crisis: the government was unable to procure fuel or food at commercial terms, and bilateral debt to creditors including China, Japan, and India required immediate renegotiation under emergency conditions rather than orderly ones.

Sri Lanka’s descent from a middle-income economy to IMF dependency within two years carries a clear message. The speed of fiscal deterioration, once multiple revenue channels come under stress simultaneously, is not linear. It can be sudden. For Middle Eastern governments that share some of Sri Lanka’s structural characteristics, a stable security environment is not merely a political aspiration. It is a fiscal prerequisite

Banking sector

Banking sector fragility compounds all three. In lower-reserve economies such as Egypt, Lebanon, and Tunisia, even a modest regional shock can trigger deposit flight and pressure on parallel exchange rates, forcing central banks to spend reserves they cannot easily replenish. By mid-2022, Sri Lanka’s usable foreign reserves had fallen below $50 million against substantial external debt obligations falling due. The country had, in practical terms, run out of options: it accepted a $3 billion IMF facility in 2023, but only after significant economic and social damage had been done. At end-2022, Sri Lanka’s total public debt stood at approximately $83 billion, with the debt-to-GDP ratio reaching around 116% according to IMF estimates.

What makes these risks particularly acute is that they compound one another. Falling tourism reduces deposit inflows to commercial banks. Declining remittances weaken currencies and erode the tax base. Trade disruption chokes export receipts while raising import costs simultaneously. Governments with fixed exchange rate regimes, limited sovereign wealth, and concentrated revenue bases face the greatest cumulative exposure through 2027. Egypt, Lebanon, and Bahrain are among those most frequently cited in this context, though the vulnerabilities differ in character across each.