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GCC Economics (2025)

Largely unaffected by recent geopolitical turmoil, the economic outlook for the Gulf economies remains fair against the backdrop of solid-to-manageable macroeconomic fundamentals. The International Monetary Fund projects solid economic growth against the backdrop of low inflation and strong current account and external financial positions. Oil prices and production levels, particularly in the case of swing producers like Saudi Arabi and the United Arab Emirates, will continue to affect economic growth, despite decades-long attempts to diversify Gulf economies away from oil and gas production. Ongoing structural reforms have helped increase the share of the non-hydrocarbon economy, even though Kuwait, Qatar, and Saudi Arabia remain highly reliant on oil and gas exports, while Bahrain and the UAE have made progress towards diversification by developing their tourism, finance, logistics, and manufacturing. 

> The IMF projects regional real GDP growth of 3.5-4% over the next few years, barring major decline of hydrocarbon output and/ or decline of hydrocarbon prices.

> GCC per capita incomes on a purchasing power parity basis vary significantly, ranging from extremely high levels in Qatar ($122,000) and the UAE ($82,000) to high levels in Bahrain ($68,000) and Saudi Arabia ($62,000) to fair level in Kuwait ($51,000) and Oman ($42,000). By comparison, U.S. per capita income is $75,000.

> Saudi Arabia is by far the largest GCC economy with a nominal gross domestic product at market exchange rates of $ 1.1 tr, compared to $550 bn in the UAE, $220 in Qatar, $100 bn in Oman and $ 50 bn in Bahrain.

> Economic and financial stability in the GCC is fair to high. Bahrain is the only country with a sub-investment grade assigned by international rating agencies. Oman has a borderline investment rating, while Saudi Arabia, Qatar, and the UAE are all rated A or higher.

Although the GCC have built fiscal buffers to counter the negative effects of lower oil prices, both their balance-of-payments and their fiscal accounts remain very sensitive to hydrocarbon prices and output, despite the greater share of non-hydrocarbon output. Except for Bahrain, the GCC have accumulated large financial buffers to withstand even prolonged oil price weakness, even if economic growth would suffer in such a scenario. GCC central banks have sufficiently large central bank foreign-exchange reserves to maintain their dollar pegs, and GCC banking systems are well-capitalized, liquidity and profitable so as not to be a significant source of contingent liabilities for their government.

> Having declined in recent years, the share of the non-hydrocarbon economy remains high in the GCC, ranging from 60-65% in Kuwait, Oman, and Qatar, to 75% in the UAE and around 85% in Bahrain.

> The GCC have formally pegged their exchange to the U.S. dollar since 2003. The majority of GCC countries had effectively pegged their respective currencies to the U.S. dollar since the 1970s and 1980s. This has helped maintain exchange rate stability and low inflation and ensured that central banks effectively shadow Federal Reserve interest rate policy.

> Public debt is low and manageable, except in Bahrain. Only Saudi Arabia and Bahrain are projected to run fiscal deficits in 2025-28. And only Saudi Arabia is projected to run a modest, very manageable current account deficit. By the end of the decade, public debt in Bahrain is projected to exceed 140% of GDP, while debt levels in all other GCC countries are projected to remain below a modest 40% of GDP.

> Regional government bonds markets have proven very resilience during the COVD-19 crisis and recent geopolitical tensions. Regional banking sectors are well-capitalized, liquid and profitable, as per the IMF.

The outlook for Saudi Arabia, the GCC’s largest economy, is fair. Like the other GCC economies, it has demonstrated significant resilience in the face of recent exogenous shocks. Non-hydrocarbon activity has been expanding, including against the backdrop of Vision 2030 related, largely government-led investment, inflation has remained low and unemployment reaching record-low levels. Like in the other GCC except for Bahrain and the partial exception of Oman, external and fiscal buffers remain significant, despite modest current and fiscal deficits. As a country with major spare oil production capacity and a country that has historically acted as a swing producers, changes in oil prices and output would, if the related revenues are channeled into the local economy, have a significant impact on the economic outlook. 

> The IEA forecast oil prices to average $69 per barrel this year, before declining to $58 in 2026 against the backdrop of a significant buildup of oil inventories. At the beginning of August, Brent crude was trading at $67.

> The IMF currently projects real GDP growth of 3.6 and 3.9% in 2025 and 2026, continued low consumer price inflation of around 2% and fiscal deficits of 4% or less in 2025-26. The Fund projects public debt to increase from a low 26% of GDP in 2024 to a modest 33% of GDP in 2026. Current account deficits will average 3% of GDP, but around half of the deficit is financed by FDI inflows. Saudi Arabia also remains a major net international creditor.

> SAMA sits on net foreign assets exceeding $400 bn, which is more than adequate to maintain the peg to the dollar. The banking sector remains solid and is characterized by high capitalization, profitability, while nonperforming loans are near ten-year lows.

Germany - A Middling Economic Outlook Despite Increased Government Spending (2025)

After years of stagnation, the German economy will receive a boost from increased government spending on defense and infrastructure, but a failure to implement flanking structural reform will fail to substantially increase medium-term economic growth. Following the breakdown of the dysfunctional three-party coalition, consisting of SPD, Greens and FDP, the February legislative elections led to the formation of a grand coalition of CDU and SPD. Following the reform of the constitutionally mandated limits on government deficits, the new coalition government has committed to significant increases in defense expenditure and infrastructure, especially transportation infrastructure investment. The new government has also agreed to implement reform aimed at reducing growth-impeding bureaucratic rules governing product markets and infrastructure investment. Intra-coalition disagreements have translated into a very limited reform agenda, and significant reform of welfare spending is opposed by the SPD, while the CDU only half-heartedly supports politically costly reform. 

> The CDU-SPD coalition controls 328 out of 630 seats in the lower house. The next lower house elections will need to be held by March 2029.

> Real GDP growth has averaged less than 1% over the past decade. Economic output decreased in three out of the past five years due to exogenous shocks (COVID-19, Ukraine war) and limited policy flexibility (debt brake).

> Constitutional reform now allows for greater fiscal flexibility by exempting defense and security, encompassing intelligence agencies and assistance to Ukraine, exceeding 1% of GDP from the calculation of the 0.35% of GDP deficit limit. As part of the reform, the German government has established a EUR 500 fund, of which EUR 100 billion will be allocated to climate change, to allocate funding to infrastructure over the next 12 years.

The significant increase in government spending in the next few years will lift short-term economic growth, provide a significant boost to its defense sector and pull the economy out of stagnation. However, if the government fails to streamline bureaucratic rules, increase incentives for increased labor market participation and implement wider growth-supporting structural reform, the medium-term effect will be limited. In this scenario, real GDP growth is not likely to exceed 1.5% over the next five years. This is because the boost to spending will be temporary and somewhat gradual. Significant labor market rigidities and costly bureaucratic rules will dampen the effect and limit the fiscal multiplier effect. Moreover, infrastructure investment may help improve the quality of the transport infrastructure as much as it will prevent a further deterioration in quality. To the extent that increased defense outlays increase demand for domestically produced goods, this will help lift output, but the spill-over effects of defense spending will also be more limited, at least compared to spending on high-tech sectors. Finally, the government coalition will also be forced to limit non-defense spending over the next few years to remain compliant with the debt brake, as the reform reform only exempts defense-related spending. Longer-term non-defense spending need will need to be brought under control and this will moderately offset spending increases over the medium term. The IMF projects real GDP growth to average 1% of GDP in 2026-2030. The German Ifo Institute forecasts real GDP growth of 1.3% for next year.

· In September, the government passed its first budget under the new debt rules. The government plans to borrow EUR 174 billion, more than triple the amount compared to 2024. The budget includes EUR 83 billion for defense spending, or EUR 117 billion if spending from the special funds is included. Total defense spending will amount to nearly 3% of GDP next year.

· In its coalition agreement, the new government has agreed to pass several administrative reform to reduce administrative regulations and reporting requirements. The government will also take on more responsibility for digitalization enforcement. The corporate income tax rate is to be reduced by one percentage point in each of five steps, starting on 1 January 2028, which will help support investment.

Financially, the German government is well-positioned to run larger fiscal deficits for an extended period of time, without it leading to a significant weakening of its financial position. Amounting to 64% of GDP, German government remains low by international standards. The IMF projects the government debt-to-GDP ratio to increase two percentage points a year with debt reaching 75% of GDP by the end of the decade. Average debt in the G7 and G20 stood at around 120% of GDP in 2024. Government debt in France, Italy, the UK and the US all exceed 100% of GDP. Moreover, government debt in the other G7 economies will continue to increase, or, in a best-case scenario, will remain unchanged. Although Germany, like all other NATO members has committed to increasing defense expenditure to 5% of GDP by 2035, it is highly unlikely that Germany or any other government will spend 5% of GDP on defense by then. Russia will not be able to sustain defense spending at current levels, and its economy is stagnating. This will allow for a significant reduction in defense spending and significant fiscal savings following the sharp increases of the next few years. Similarly, infrastructure spending, once the investment fund has been exhausted, will be self-liquidating from a budgetary point of view. Meanwhile, the German government will be forced to keep limit the non-defense deficit to 0.35% of GDP. This will effectively limit the size of fiscal deficit over the next few years.

> The IMF projects government pension and healthcare expenditure to increase by 0.4% and 0.4% of GDP respectively between now and 2030. It estimates the net present value of pension and healthcare expenditure at 13% and 35% of GDP, meaning Germany, like most other advanced economies, is faced with significant increases in social welfare spending over the next few decades.

> In the coalition agreement, the CDU and SPD agreed to welfare spending reform, but the agreement primarily focuses on increasing but has failed to provide a substantial roadmap toward reining in the projected increases in welfare spending. The government has established a commission due to provide proposals by 2027, suggesting that the government is not serious about reform, as the SPD largely opposes spending-related reform while the CDU is less than keen on it.

Significant increases of defense spending over the next few years will lead the German government and German industry to take the initiative and play a leading role on defense-industrial cooperation in Europe. Germany plans to increase defense expenditure by 70% by 2039 to exceed EUR 160 billion meaning increased defense spending will prove sustainable, politically and financially, creating greater incentives for the private sector to participate in various projects. German defense companies will benefit greatly from increased spending, which will lead to significant innovation given Germany’s large industrial-technological base. Increased increased defense spending will also benefit Europea’s defense-industrial base in terms of demand, planning horizons and investments. As for the German government, the UK and Italy, and especially will face significant greater budgetary constraints in terms of defense spending increases, despite their official commitment to increase expenditure to 5% of GDP by the middle of the next decade. Germany’s financial flexibility will put it in a position to strongly shape future EU- and European policies. However, it will continue to oppose the issuance of common debt to finance EU defense expenditure, beyond the financial agreements already reached (see below). With Germany taking the lead, however, European initiatives will be more open to cooperation, including production, development and procurement, with non-EU countries.

> Germany will remain by far the largest European provider of military aid to Ukraine. The 2026 budget foresees EUR 9 billion in aid.

> Germany has threatened to drop France as its major partner in the development of sixth-generation fighter aircraft in the context of Future Combat Air System (FCAS), launched in 2017, and may to go ahead with its remaining partner, Spain, or explore cooperation with Sweden and the UK, while joining Global Combat Air Programme led by the UK, Italy and Japan is not probable at this point.

> The EU helps finance European defense spending through a variety of financial and non-financial instruments. The European Defence Fund provides funding for defense research and development as well as capability development projects, promoting cooperation among EU defense companies. The Security Action for Europe provides EUR 150 billion worth "loans fr arms" to provide financial assistance to Member States for defense investments. Finally, the EU now also provides greater flexibility under the Stability and Growth Pact by allowing members to activate the National Escape Clause for higher defense spending, while defense-related projects.