Dubai: The recent interest rate hike by the US Federal Reserve and potential guidance of three to four hikes in 2018 has adverse consequences for private sector credit growth, economic diversification efforts and economic growth of GCC countries in the year ahead and beyond.

Economists expect that, with the growing optimism on US jobs and wage growth, the Fed is likely to raise policy rates four times in 2018 compared to the earlier forecast of three hikes.

The US rates are being pushed up by domestic factors, primarily the Fed’s balance sheet reduction and expected economic growth. However, economists predict these are likely to have unintended consequences on countries that have dollar-pegged currencies like in the GCC.

“The current divergent economic cycles between the US and the GCC along with lower oil prices imply different fiscal and monetary policy needs. However, monetary policy in the GCC is determined by the exchange rate peg to the US dollar,” said Boban Markovic, research analyst at the Institute of International Finance (IIF), the Washington headquartered association of leading global banks and financial institutions.

The International Monetary Fund (IMF) expect the region’s growth outlook to face some downside risks in 2018. While the IMF expects considerable uncertainty to surround the oil price outlook, downside risks from regional conflicts and geopolitical developments also remain. “A few global risks could also affect the region, including faster-than-expected normalisation of monetary policy in the US, and the pursuit of inward-looking policies by advanced economies,” said Jihad Azour, Director of the IMF’s Middle East and Central Asia Department.

In response to the December Fed rate hike of 25 basis point (0.25 per cent) to 1.5 per cent, Saudi Arabian Monetary Authority (SAMA), Saudi Arabia’s central bank raised its reverse repo rate, the rate at which commercial banks deposit money with the central bank, by 25 basis points to 1.5 per cent. The Saudi central bank also said it was keeping its repo rate, used to lend money to banks, unchanged at 2 per cent.

Bahrain’s central bank also raised its key interest rate by 25 basis points. The central bank’s key policy interest rate on the one-week deposit facility was raised to 1.75 per cent from 1.50 per cent. In addition, the overnight deposit rate was lifted to 1.50 per cent from 1.25 per cent, the one-month deposit rate to 2.40 per cent from 2.15 per cent, and the lending rate to 3.50 per cent from 3.25 per cent.

The Central Bank of UAE increased interest rates on the issuance of its certificate of deposits by 25 bps to 1.75 per cent. Qatar increased the rate on its repo facility from 2.25 per cent to 2.5 per cent. Oman’s policy rate continued to be linked to the one-month Libor [London interbank offered rate] rate by keeping the 50bps spread. Kuwait, the only GCC country with a basket-pegged currency (euro and dollar), kept its policy rate on hold for the second time this year.

Muted growth

Still grappling with the aftermath of the oil crash and the subsequent necessary fiscal adjustment, the IIF expects GCC non-oil growth to be muted at around 2 per cent for 2017 and 2018, well below the average of 6.6 per cent in 2006-2015. While the governments across the region are easing fiscal consolidation efforts in 2018, Saudi Arabia has announced an expansionary budget, pushing fiscal targets set for 2020 to 2023 to give the non-oil economic growth the much-needed push.

Despite the fiscal easing on the horizon, economists and analysts say limited monetary policy flexibility could hurt growth outlook. Relatively tighter monetary conditions and the introduction of the Value Added Tax (VAT) at 5 per cent in early 2018 could mean further tightening of credit conditions. With the implementation of VAT (in Saudi Arabia and the UAE), it will be interesting to see how borrowers react to simultaneously rising costs,” said Emilio Pera, partner and Head of Financial Services at KPMG Lower Gulf.

The combined impact of rate increase and higher operating costs from VAT, according to economists, impact the pace of real non-oil GDP growth in the region.

“Empirical studies, based on panel regressions, show that the spillover from US monetary policy tightening is larger when combined with lower oil prices. For example, our estimates show that a 100bps [1 per cent] increase in US real interest rates decreases the GCC’s annual non-oil growth by more than 0.5 percentage points if oil prices fall from an average of $55 per barrel in 2017 to $45 a barrel in 2018,” said Gregory Basile, senior research analyst at IIF.