Economies and markets in the wealthy Gulf oil exporters barely blinked when Islamist militants overran parts of neighbouring Iraq last year, and they look likely to ride out escalating conflict in Yemen with similar ease.

Air strikes against Houthi forces in Yemen by Saudi Arabia on Thursday raised the prospect of a proxy war, with Shi'ite Iran backing the Houthis and Riyadh plus other Sunni Muslim monarchies supporting Yemeni President Abd-Rabbu Mansour Hadi.

A war would probably dent the confidence of international investors in the entire Gulf. It could pose a domestic security challenge for Saudi Arabia, and deny Dubai and Oman the economic benefits of a hoped-for rapprochement with Iran if there is an international agreement on Tehran's disputed nuclear programme.

As a result, stock markets in the six Gulf Cooperation Council states - Saudi Arabia, the United Arab Emirates, Kuwait, Qatar, Oman and Bahrain - slid on Thursday, with the Saudi index down 1 per cent after a 5 per cent plunge on Wednesday.

But other market indicators showed little worry. Gulf bonds barely moved and credit default swaps, used to hedge against sovereign defaults, rose only marginally; five-year Saudi CDS are up just 4 basis points in the past week.

That is because the GCC states have shown over the last few years that they're able to insulate their economies from geopolitical threats, such as the turmoil in Iraq and the Arab Spring uprisings of 2011, fund managers and analysts said.

Sergey Dergachev, senior portfolio manager for emerging market debt at Union Investment Privatfonds in Germany, which has about 10 billion euros ($11 billion) of emerging market debt under management, said he did not expect Yemen to prompt any large-scale reassessment of investments in the GCC.

"The impact on key GCC countries like Qatar or UAE will be miniscule in terms of their credit profile," he said, adding that any selling of bonds by foreign investors would be offset by local institutions buying in at cheaper levels.

Saleem Khokhar, managing $3 billion of assets as head of equities at National Bank of Abu Dhabi, said the Yemen conflict was a political concern but would not have a dramatic impact on economies in the region.

"I don't think it'll derail economic prospects as a whole for the GCC," he said. "Weakness in the stock market is to be short-lived - the market should then begin to stabilise, settle and recover."

LOCAL INVESTORS

The GCC has almost zero economic exposure to Yemen, analysts said - even less than it does to Iraq, where some GCC energy and telecommunications firms have big operations that have suffered over the past six months.

In fact, as past geopolitical crises have shown, GCC economies may actually benefit from the Yemen conflict if it pushes up oil prices, increasing export revenues. Yemen has been selling about 1.4-1.5 million barrels of oil per month; if that dries up, Saudi Arabia may fill much of the gap.

So the risk for the GCC is any expansion of the conflict beyond Yemen's borders, said Abdul Kadir Hussain, who oversees about $1.2 billion in assets as chief executive at Mashreq Capital, the investment unit of Dubai's Mashreq bank.

"I think the probability of such an event is very low, but clearly the impact of something like that would be very high."

Dergachev said he was concerned about the potential role of Yemeni workers in Saudi Arabia, who have been estimated to number around 1 million or more. Other risks include regional terrorism and the mass movement of refugees across borders.

There is no clear sign that any of these risks will materialise, however, and the GCC has resisted such threats for years. Saudi Arabia expelled all Yemeni workers in 1990 after Iraq invaded Kuwait, and expelled tens of thousands in 2013 and 2014 during a crackdown on illegal foreign labour.

Many analysts attributed this week's slide of the Saudi and other Gulf stock markets as much to profit-taking and concern about upcoming first-quarter earnings as to geopolitics.

"If the situation remains contained and does not spread out, the markets will stabilise or even rebound," said Shakeel Sarwar, head of asset management at Securities & Investment Co in Bahrain.

Thomas Byrne, senior vice president of the sovereign risk group at Moody's Investors Service, told Reuters: "Based on what we see unfolding at this time, if the strife in Yemen is contained, we will not likely change our assessment of geopolitical risk for the GCC." – Reuters