With the free-fall in oil prices, should US defense firms worry about arms exports to the Gulf?
What do you do when your customer is in financial crisis?

There has been a lot of press about what it means to the US defense industry as the Gulf states suffer from declining petroleum prices. As the ominous oil headlines continue, what does this mean for arms purchases by Gulf states that are so dependent on oil revenues?

The stress on the economies of Saudi Arabia and its Gulf Cooperation Council (GCC) allies is becoming increasingly evident.Saudi Arabia recently announced public spending cuts and increasesin taxes, fuel and energy prices in 2016 in reaction to a soaring $98 billionbudget deficit as 2015 revenues ended 15 percentbelow official expectations.

With the declining financial picture and emerging domestic austerity, it is would be natural to wonder about future arms purchases – one of the largest discretionary spending categories.

However, in parallel with the GCC economic declines, the security situation in the region has been deteriorating. Iran's strength has been bolstered by international legitimacy and an improving economy after the nuclear accord. Iran has fueled proxy wars between the Sunni and Shia groups, with the Yemen conflict remaining hot, and tensions multiplied with the recent Saudi execution of a Shiite cleric and its aftermath, including destruction of the Saudi Embassy in Tehran and cessation of diplomatic ties between Iran and Saudi Arabia.

Iran, with its Russian ally, also has interests in undermining fledging peace deals in Syria.

In the tug-of-war between declining economic strength and deteriorating security, what gives? History The first clue is from history. Our analysis shows a strong correlation between oil prices and military spending over the last four decades. But the connection breaks — in favor of stronger military spending — when there are steep oil price drops.

In the late 1980s it took seven years for the sharp oil price decline to be meaningfully reflected in defense spending. In 2009, the oil price drop was brief, and the blip did not noticeably affect the steady growth in those countries' military spending.

With the perceived acute security situation on multiple external and internal fronts, Gulf states are likely to sustain healthy levels of defense spending and arms purchases even in the face of persistently low oil prices.

So does this spell out good news for US arms exports? The answer to this is more nuanced. Arms purchases in the Middle East are driven by a combination of need for weaponsand international relations between the buying and selling countries.

On the heels of the Obama Camp David summit last May there have been notable multibillion dollar US-Saudi deals for precision weapons and warships. But the Saudis are also looking to other non-US sources such as Turkey to enhance their bilateral relations with other countries dissatisfied with the Iranian-Russian axis and its push for influence in the region.

Another complication is that the poor fiscal situation will raise the bar for US weaponexporters as Gulf customers push for more offsets to strengthen and diversify their local economies.Nonetheless, spending will remain robust as the monarchs see stability and security as enablers of their power.

Our bet is that if the tensions remain at today's levels, security will trump fiscal responsibility and arms exports to the region will remain strong, albeit with a more demanding set of customers.

David Handley is a senior adviser to SM&A and previously served as director for the Middle East and Africa for the UK Security Service. (MI5).Dr. Alan Berman is vice president of management consulting at SM&A.

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