Economic Implications of the Recent Middle East Conflict for Sri Lanka: GDP Growth, Inflation, CA Balance, and Foreign Exchange Stability

Abstract

This study examines the macroeconomic implications of the ongoing Middle East conflict for the Sri Lankan economy, with a particular focus on key transmission channels including energy prices, remittances, trade, and external sector stability. Using annual time-series data from 2000 to 2025, the paper employs an Autoregressive Distributed Lag (ARDL) framework to estimate both short-run and long-run relationships between global oil price shocks, remittance inflows, and major macroeconomic indicators such as GDP growth, inflation, exchange rate dynamics, and the current account balance. The empirical findings confirm that oil price shocks exert significant adverse effects on economic growth while simultaneously increasing inflationary pressures and external imbalances. In contrast, remittances play a stabilizing role by supporting foreign exchange availability and domestic demand. The results highlight that Sri Lanka’s macroeconomic performance is highly sensitive to external geopolitical developments due to its structural dependence on imported energy and migrant labour income. To complement the econometric analysis, the study develops scenario-based simulations under moderate, escalated, and severe conflict conditions. The results indicate that a prolonged conflict could significantly weaken economic growth, accelerate inflation, depreciate the exchange rate, and widen the current account deficit. These findings underscore the vulnerability of Sri Lanka’s recovery trajectory in the face of external shocks. The paper concludes by emphasizing the need for proactive and forward-looking policy measures, including energy diversification, export market expansion, strengthening of remittance channels, and prudent macroeconomic management. Overall, the study contributes to the policy discourse by providing evidence-based insights into how geopolitical instability in the Middle East can influence small, open, and import-dependent economies such as Sri Lanka.