Three days after Ali al-Zaidi was sworn in as Iraq’s new prime minister in May, three drones launched from Iraqi territory targeted critical infrastructure in the United Arab Emirates (UAE), including one that struck the perimeter of the Barakah nuclear power plant. The Emirati Ministry of Defense traced all three drones to Iraqi territory. On the same day, Saudi Arabia intercepted three additional drones entering its airspace from the same direction. Alarming in its own right, the incident was also the latest in a series of attacks that has unraveled a decade of Iraqi diplomatic work in the Gulf.

Over the past decade, Baghdad invested significant political capital in escaping the regional isolation that had defined it since 1990. It rebuilt trade ties with the Gulf states, pursued electricity grid integration with Kuwait and Saudi Arabia, leveraged the 2023 Saudi-Iranian détente to present itself as a neutral bridge, attracted serious Gulf investment for the first time in a generation, and hosted the Arab Summit in 2025. That project is now unraveling. The cause is not external aggression but a contradiction Iraq’s Shia political leadership embedded within the state’s own structure: the decision to absorb Iranian-commanded militias into the state payroll while assuming that such an arrangement was compatible with sovereign, good neighborly relations. A wave of drone and missile strikes by those same militias against critical infrastructure in Saudi Arabia, Kuwait, and the UAE, together with attacks on Gulf diplomats on Iraqi soil, has finally brought that illusion to an end.

For Zaidi, sworn in on May 14 with only a partial cabinet and key portfolios such as interior and defense still unfilled, the question is no longer how to balance Iranian influence against Gulf engagement. That question assumed a manageable equilibrium. The real question now is whether the Iraqi state, as currently constituted, can withstand the consequences of its own internal design.

A Decade of Resetting Ties with the Gulf States

Baghdad’s post-ISIS diplomatic campaign was the most ambitious effort to rehabilitate Iraq’s regional standing in its modern history. Oil revenues distributed through a bloated patronage system could no longer sustain a functioning state or meet the needs of a growing population. Iraq needed Gulf capital, regional trade corridors, and integration into energy projects that only its wealthy southern neighbors could finance. It also needed to shed its image as a failed-state buffer between Tehran and Riyadh.

Progress was gradual but tangible. Iraq signed electricity interconnection agreements with the Gulf Cooperation Council (GCC). In December 2022, the GCC Interconnection Authority launched an estimated $220 million project involving 400-kV double-circuit overhead lines stretching approximately 295 kilometers from Kuwait’s Al-Wafrah substation to Iraq’s Al-Faw substation. Saudi Arabia reopened the Arar border crossing in November 2020 after nearly three decades of closure — a step widely regarded as the most significant move toward normalization since the 2003 overthrow of Saddam Hussein. Riyadh dispatched ambassadors, hosted Iraqi delegations, and began channeling investment toward reconstruction. The UAE and Qatar followed suit. By 2022, Baghdad was hosting regional summits and, with some justification, positioning itself as a diplomatic intermediary between the Persian and Arab worlds.

The Saudi-Iranian détente accelerated this momentum. On March 10, 2023, under Chinese mediation, Saudi Arabia and Iran agreed to restore diplomatic relations after a seven-year rupture and to revive their 2001 security cooperation pact. As Riyadh and Tehran scaled back their rivalry, pressure on Iraq to align with one side diminished. Iraqi officials increasingly portrayed the country as a “meeting point” rather than a battlefield. Investment memoranda multiplied. Gulf logistics firms expressed renewed interest in Basra’s port infrastructure. GCC states pledged support for Iraq’s ambitious Development Road project, designed to connect the Gulf with Europe through Türkiye. Even the long-delayed Faw Grand Port project — a $4.9 billion deep-water port designed to handle 99 million tons of cargo annually — drew renewed interest.

For the Gulf states, Iraq represented a strategic hedge: a Shia-majority Arab country that, if properly cultivated, could help counterbalance Iranian influence across the Fertile Crescent. Saudi and Emirati policymakers recognized that drawing Iraq into the Gulf’s economic orbit would weaken Tehran’s grip over Baghdad more effectively than any sanctions package. Their approach was patient, transactional, and grounded in mutual interest. It was also cautious. Much of the promised investment remained at the memorandum-of-understanding stage, slow to convert into disbursed capital. Riyadh and Abu Dhabi were conducting a low-cost strategic experiment, testing whether Iraq’s political leadership could deliver sufficient stability, predictability, and sovereignty to justify deeper commitment. The approach allowed the Gulf states to disengage with minimal cost if the experiment ultimately failed. 

The Payroll Problem

The fault line at the center of this crisis is not new. Analysts have warned about it for years. What has changed is that the escalation since late February has transformed a longstanding governance challenge into a regional security liability.

The Popular Mobilization Forces (PMF) were formally integrated into Iraq’s security apparatus on November 26, 2016, when parliament enacted Law No. 40, placing the organization within the Iraqi Armed Forces under the authority of the commander-in-chief. In practice, this meant that groups such as Kata’ib Hezbollah, Asa’ib Ahl al-Haq, and Harakat Hezbollah al-Nujaba received salaries from the national budget and operated under a nominal chain of command linked to the prime minister’s office. By 2024, the PMF counted roughly 238,000 fighters with an annual budget approaching $3.6 billion. In legal and fiscal terms, its fighters are state employees.

The decision to integrate the PMF was not irrational. From the perspective of Iraq’s Shia political leadership in 2016, it was a calculated response to an exceptional set of circumstances. PMF factions had played a decisive role in the campaign against ISIS after Grand Ayatollah Ali al-Sistani issued his 2014 fatwa calling on Iraqis to take up arms. Tens of thousands of fighters had helped reclaim territory that the regular army had abandoned. Refusing to incorporate these fighters risked postwar fragmentation, leaving dozens of armed groups holding combat experience, popular legitimacy within the Shia community, and little institutional allegiance to Baghdad. Integration was intended to bring them within the state’s formal framework, subject them — at least nominally — to government authority, and place their fighters on a salaried payroll that Baghdad could, in theory, oversee. The assumption was that formal incorporation would give the state greater leverage over armed groups that were unlikely to disappear regardless. That calculation has proved deeply flawed, but understanding why it was made is essential to understanding why the resulting contradiction has become so difficult to absorb.

Operationally, however, the PMF’s most powerful factions function as instruments of Iranian regional policy. Although they are formally part of the Iraqi Armed Forces, their senior commanders openly acknowledge Iran’s Supreme Leader as their commander-in-chief. In April 2024, PMF Chief of Staff Abdal-Aziz al-Mohammadawi, better known as Abu Fadak, traveled to Tehran for the Quds Day march and stated that the PMF was awaiting guidance from Ayatollah Khamenei on how to respond to the regional crisis — an extraordinary admission by the highest-ranking officer of a state-funded force. The US National Counterterrorism Center likewise describes Kata’ib Hezbollah as working “extensively” with the Islamic Revolutionary Guard Corps’ (IRGC) Quds Force and closely following the direction of Iran’s Supreme Leader.

The orders for the drone attacks launched by Shia militias against Gulf states did not originate from the Iraqi government. Instead, the chain of command that authorized the strike runs through the Quds Force in Tehran. Yet Iraq is paying the salaries of those who carried them out. That contradiction now bleeds into every relationship Iraq has worked to rebuild with its Gulf neighbors.

Previous governments managed the problem through a combination of strategic ambiguity and deliberate delay. Prime ministers from Haider al-Abadi to Mohammed Shia al-Sudani publicly asserted the state’s sovereign authority over the PMF while privately acknowledging they either could not — or, in many cases, would not — confront its most powerful factions. This arrangement rested on three assumptions: first, that the militias would exercise sufficient restraint to avoid provoking a decisive rupture; second, that Iran, having secured deeply embedded influence within the Iraqi state, had an interest in preserving stability; and third, that the Gulf states would continue to tolerate the fiction because the economic incentives for engagement outweighed the associated security risks.

The campaign waged since February under the banner of the “Islamic Resistance in Iraq” (IRI) has destroyed all three assumptions. The IRI serves as an umbrella framework for the principal Iran-backed Shia militias operating in Iraq, including Kata’ib Hezbollah, Kata’ib Sayyid al-Shuhada, Asa’ib Ahl al-Haq, and Harakat Hezbollah al-Nujaba. Since the US-Israeli campaign against Iran began on February 28, 2026, these groups have carried out hundreds of drone and rocket strikes against US forces, American diplomatic facilities, the Kurdistan Region of Iraq, and targets in Gulf states. According to US officials, attacks on American positions alone have exceeded 600.

The Strikes and Their Logic

The militia offensive emerged from the broader regional fallout of the Gaza war and Iran’s strategy of activating its network of regional proxies. Iraq, however, is neither Lebanon nor Yemen. Hezbollah and the Houthis operated from territories that made no claim to neutrality. Iraq did. That distinction has made attacks launched from Iraqi territory far more diplomatically damaging and helps explain the strategic logic behind the campaign.

The attacks have followed a deliberate progression. Early strikes focused on energy infrastructure, building on an established precedent. Saudi Arabia’s eastern oil facilities had been targeted before. On September 14, 2019, drone and cruise-missile strikes damaged Saudi Aramco’s Abqaiq processing facility and Khurais oil field, temporarily knocking out 5.7 million barrels per day of production, more than half of Saudi Arabia’s output and roughly five percent of global supply. At the time, US officials traced portions of that strike to Iraqi territory, although Tehran denied involvement.

The 2026 strikes carry a different charge. Drone attacks targeted fuel-storage facilities at Kuwait International Airport on March 8 and on April 1, with Al Arabiya later reporting that additional strikes on Kuwaiti National Guard sites originated from Iraqi territory. The May 17 strike near the Barakah nuclear plant in the UAE, which Emirati authorities confirmed was launched from Iraq, marked a qualitative escalation. It struck the perimeters of nuclear infrastructure during a precarious US-Iran ceasefire that had held only intermittently since April 8. The UAE Ministry of Foreign Affairs called on Iraq to “prevent all hostile acts” from its territory. Baghdad’s response followed its usual pattern: a statement of condemnation coupled with the formation of an investigative committee.

The most damaging strikes targeted diplomatic facilities. On March 9, a drone attack hit near the UAE Consulate General in Erbil; a second drone attack on March 14 struck the consulate directly, injuring two security personnel. Two days later, a drone hit Baghdad’s Al-Rasheed Hotel in the Green Zone, which hosts the Saudi Embassy and other diplomatic offices, including the EU Advisory Mission, while a near-simultaneous attack hit the US Embassy compound’s helipad. In the days that followed, Saudi and Qatari diplomats began withdrawing diplomatic personnel from Iraq, citing the deteriorating security environment.

Taken together, the strikes demonstrated that the militias could reach Gulf critical infrastructure, threaten the aviation hubs that underpin the region’s role as a global transport center, and target diplomatic facilities inside Iraq with effective impunity. They also pushed GCC states beyond public condemnation. Saudi and Kuwaiti forces subsequently conducted limited kinetic strikes against militia staging areas in western and southern Iraq, carefully calibrated to avoid Iraqi military casualties but visible enough to deliver a clear message: if Baghdad cannot police its own territory, Gulf states will. For a country that has spent two decades attempting to restore its sovereignty after 2003, these GCC strikes represent a profound strategic setback. They are also entirely foreseeable.

The Dollar Lever

The military dimension of this crisis, while dramatic, is ultimately secondary to its economic implications. Iraq’s greatest vulnerability lies in its dependence on the US dollar — and Washington is fully aware of it.

The Iraqi economy is dollar-dependent in a way that gives the United States extraordinary coercive reach. Iraq’s oil revenues are deposited in an account at the Federal Reserve Bank of New York, a mechanism that traces its origins to the Development Fund for Iraq, established in 2003. The account serves as the custodian and clearinghouse for the Central Bank of Iraq (CBI). The CBI converts these dollar revenues into dinars through a daily foreign currency auction, while roughly $10 billion in physical US currency is flown to Baghdad each year to meet domestic cash demand. Iraq’s import-dependent economy cannot function without this steady supply of dollar liquidity.

This monetary mechanism is arguably Washington’s most powerful tool. If Baghdad fails to demonstrate credible action against the militias attacking American allies, Washington can restrict Iraq’s access to dollar liquidity. When dollar inflows tighten, the dinar weakens on the parallel market, import prices rise, and the political elite that depends on patronage spending loses its main instrument of domestic control.

Baghdad has already experienced the consequences of this leverage. In late 2022, the New York Fed imposed strict controls on international dollar transactions by Iraqi banks to halt illegal transfers to Iran. In July 2023, the US Department of the Treasury and the Federal Reserve banned 14 Iraqi banks from conducting dollar transactions over money-laundering and Iran-linked fraud concerns. The dinar dropped sharply on the parallel market, with the black-market rate spiking well above the official rate, fueling public anxiety. Eight additional banks were banned in 2024, and in late April 2026 Washington partially suspended physical dollar shipments tied to Iraq’s oil exports until Baghdad demonstrated movement against the militias.

That increasing pressure comes as al-Zaidi travels to Washington in mid-July for his first foreign trip since taking office, at the invitation of President Donald J. Trump. The visit follows Special Presidential Envoy Tom Barrack’s meetings in Baghdad on June 15, during which the two governments publicly committed themselves to the “complete disarmament and disbandment of all armed groups” operating outside the authority of the Iraqi state. Al-Zaidi is expected to arrive in Washington with a concrete roadmap outlining how Baghdad intends to fulfil that commitment, including implementation timelines, verification mechanisms, and guarantees that Iraqi territory will no longer be used to threaten neighboring states. Washington, for its part, signaled in early May that dollar transfers and security assistance would resume once concrete steps were taken against the militias. The underlying message is hard to miss. The plan al-Zaidi presents in Washington will largely determine whether the dollar tap is reopened, while Gulf capitals will calibrate the pace of their own re-engagement against the same benchmarks.

Yet the dollar lever carries significant costs of its own as it punishes the Iraqi economy as a whole rather than the militias alone. Restricting dollar liquidity erodes the purchasing power of ordinary Iraqis, fuels inflation, and creates the kind of economic hardship that has historically expanded the recruitment pool for armed groups. At the same time, the PMF factions maintain parallel revenue streams, including smuggling networks, border tolls, Iranian subsidies, and extortion economies, none of which pass through the official dollar supply chain. Washington’s financial pressure therefore falls primarily on the Iraqi state. The militias were deliberately structured to function beyond its reach.

Al-Zaidi’s Options

Prime Minister al-Zaidi, only weeks into his tenure and still without ministers for the interior and defense portfolios, faces three broad courses of action. None offers an easy or risk-free solution.

The first is direct confrontation with the PMF factions responsible for the strikes. Such a course would risk fracturing Iraq’s security establishment, alienating the Shia political blocs that constitute the core of his parliamentary support, and potentially triggering armed conflict in Baghdad and the southern provinces. These militias are not fringe actors. They control neighborhoods, operate economic and social-service networks, and maintain deep roots throughout Iraq’s Shia-majority regions. A campaign against them would resemble far more than a law-enforcement operation; it could become the opening stage of an intra-Shia civil war. Since 2020, Iraqi security forces have conducted raids against Kata’ib Hezbollah in attempts to disarm groups that refuse to submit to state authority, but the results have been limited and largely symbolic. The most powerful factions have consistently absorbed political pressure, waited for the immediate crisis to subside, and resumed their activities. Confrontation without the capacity to prevail would likely leave al-Zaidi in a weaker position than inaction.

The second option is the approach Baghdad has historically favored: symbolic action. Arrest warrants are issued but never enforced. PMF units are nominally reshuffled but operationally untouched. Public condemnations are accompanied by back-channel communication with militia commanders. This strategy bought time in previous crises because the consequences of militia activity remained below the threshold that would trigger a decisive external response. That threshold has now been crossed. The attacks on Kuwait International Airport, the Barakah nuclear power plant, and Al-Rasheed Hotel all exceeded the level that Gulf states are prepared to tolerate. They now expect verifiable reductions in militia capabilities rather than symbolic gestures. Gulf states are calibrating responses to Iraqi actions, not Iraqi statements. Symbolic measures will be read as confirmation that Baghdad has chosen the militias over its neighbors.

The third option is to negotiate directly with Tehran to restrain the militias in exchange for Iraqi concessions on issues such as sanctions enforcement and border transit. At first glance, this approach has practical appeal because it is the only option likely to produce meaningful changes in the behavior of armed groups that are stronger than many of the Iraqi institutions meant to govern them. Yet it would effectively place Iraq’s national security in the hands of the very foreign power whose proxies created the crisis. It might purchase temporary restraint, but not a durable solution, while reinforcing the perception among Iraq’s Arab neighbors that the country’s security decisions are ultimately shaped in Tehran rather than Baghdad. 

In practice, al-Zaidi has opted for a variation of the first path, relying on deadlines rather than immediate enforcement. His government has given all armed groups until September 30 to surrender their weapons to the state — a date chosen to coincide with the completion of the withdrawal of the US-led international coalition, thereby removing the principal justification that holdout factions have long cited for retaining their arsenals.

The response has split the militia landscape. Muqtada al-Sadr’s Saraya al-Salam began surrendering weapons and headquarters to the Samarra Operations Command in early June, while Asa’ib Ahl al-Haq and Kata’ib al-Imam Ali announced the transfer of their brigades, personnel, and inventories to state control. The hard core of the Islamic Resistance in Iraq has refused. Kata’ib Hezbollah and Harakat Hezbollah al-Nujaba, the groups most directly implicated in the strikes on Gulf targets, insist that disarmament cannot even be discussed under American pressure.

That split makes September the hinge on which everything else turns, with three plausible outcomes. The best case — full compliance with the deadline — would require Kata’ib Hezbollah to surrender the very military capabilities that underpin both its domestic influence and Iran’s regional deterrence strategy. Nothing in the group’s history suggests it is prepared to do so. The worst-case scenario is that an attempt to enforce the deadline triggers the intra-Shia confrontation described above. The most likely outcome lies somewhere between these two extremes: partial compliance. Cooperative factions complete their carefully choreographed handovers, the government declares the initiative a success, while the holdout groups retain their drone and missile inventories and challenge Baghdad to act. When asked what would happen to factions that remained armed after the deadline, the government spokesman stated only that Baghdad would consider “legal measures,” — the language that reflects the symbolic second path rather than genuine enforcement.

Partial compliance carries a paradox that deserves emphasis. By separating the cooperative factions from the defiant ones, the disarmament process would leave the state’s monopoly on the use of force contested precisely by the groups that pose the greatest threat to Iraq’s neighbors. At the same time, the final withdrawal of US-led coalition forces would remove one of the last external constraints on those factions’ freedom of action. If September 30 passes with Kata’ib Hezbollah still armed and unpunished, Riyadh, Abu Dhabi, and Washington are likely to conclude that the entire disarmament campaign was largely performative. In that case, the financial and military pressure described in this paper would almost certainly resume with greater intensity and fewer political restraints.

If the deadline collapses and al-Zaidi retreats into inaction, external pressure will only intensify. Saudi and Emirati strikes could expand in response to attacks from Iraqi soil. The dollar freeze deepens. Gulf capital redirects to Jordan, Egypt, and other destinations carrying less geopolitical risk. Iraq’s reintegration into the regional order collapses, leaving Baghdad dependent on an Iran that is itself constrained by severe sanctions and increasingly unable to substitute for Gulf capital and investment.

What Comes Next

Absent a dramatic shift in either Iraqi domestic politics or Iranian strategic priorities, the near-term trajectory points to a continued erosion of Iraqi sovereignty and mounting challenges for both Iraq and its neighbors.

The factions that have refused to disarm have little incentive to change course. Attacks on Gulf infrastructure serve Iranian strategic objectives, reinforce the militias’ domestic political standing, and impose costs on the regional actors most opposed to Tehran. Such attacks are therefore likely to continue as long as these groups retain both the capability to carry them out and the political cover to shield them from meaningful consequences.

Gulf states, meanwhile, will keep hardening. Saudi Arabia has already demonstrated willingness to use force inside Iraqi territory, and the absence of serious Iraqi or international pushback has lowered the bar for future operations. Kuwait’s security establishment now treats southern Iraq as a threat vector rather than a trading partner. The diplomatic architecture assembled over the past decade is being dismantled faster than it was built.

Washington will continue applying financial pressure while avoiding direct military confrontation with the militias. Roughly 2,500 US troops remain in Iraq, largely consolidated in the Kurdistan Region after the phased withdrawal from non-Kurdish areas completed in early 2026 under a September 2024 agreement that envisions further drawdown around September 2026.

Conditions on the ground argue strongly against adhering to that timetable. American forces remain deployed in a country where Iranian-backed militias that receive state funding continue to attack US troops, American diplomatic facilities, and Washington’s regional allies, while a brand-new prime minister pleads for time he does not have. Maintaining a presence in the Kurdistan Region remains the lowest-cost option available to American policymakers for ensuring the militias do not escalate further. Accordingly, the GCC should apply pressure on Washington to keep the US military in the Kurdistan Region as an essential element of regional deterrence. 

The Kurdistan Region itself deserves attention as a distinct variable. The region is the primary host for American forces, the site of significant Gulf investment, and a potential alternative anchor for Gulf engagement with Iraq if relations with Baghdad collapse entirely. Erbil has cultivated its own diplomatic and commercial relationships with Riyadh, Abu Dhabi, and Ankara, partly as a hedge against Baghdad’s instability. How the Kurdistan Regional Government navigates among Baghdad, Tehran, and the Gulf states in the months ahead will determine whether Iraq retains any institutional foothold in the Gulf economic order — or whether the Kurdistan Region becomes the only viable channel. The drone strikes on the UAE Consulate in Erbil suggest the militias recognize this dynamic and are working to close that channel too.

The likely end state, if current dynamics hold, is Iraq’s quiet re-isolation. It will look less like the hard containment of the 1990s and more a slow exclusion from the regional order. Investment will reroute. Iraq’s ambitious Development Road will stall indefinitely. The country will drift deeper into Iran’s orbit, not necessarily because Baghdad consciously chose that path, but because alternative partnerships were systematically undermined by armed groups that the Iraqi state finances, protects, and remains unable to control.

Iraq’s neighborhood problem is, fundamentally, a sovereignty problem. PMF integration was designed to neutralize a militia threat to the state. It instead converted that threat into a permanent feature of the state — one now directed outward at every partner Iraq depends on for economic survival. No declaration from Baghdad and no policy review in Washington can resolve this without confronting the question Iraq’s political class has spent a decade avoiding: “Who governs Iraqi territory?” Until the new government in Baghdad can offer a credible answer, the Gulf states are unlikely to restore confidence in Baghdad, the dollars will flow less freely, and the militias will not stop.

This article is republished from Emirates Policy Center. Read the original article.