Those lessons about interest rates need reworking
A strong dollar segues into higher values for Gulf currencies, which will make their exports pricier. Image Credit: Gulf News

When it comes to soaring inflation, there are few options other than to raise interest rates, which is what the US Federal Reserve did – by 50 basis points - and replicated by other central banks to varying degrees.

Since the GCC currencies are pegged to the US dollar, there was a need for the Gulf to raise benchmark interest rates by the same percentage. Accordingly, their central banks raised the rates, which should go a long way in curbing inflationary spikes.

This is with the knowledge that the average inflation rate is at 3 per cent in the GCC, still low rates compared to 7-10 per cent in the EU and the US, easily the highest levels in four decades. Given the importance of interest rates and their economic consequences, questions have arisen about their impact on the GCC economies.

First, the most important conclusion is that the GCC economies will not suffer a stagflation from rising interest rates, unlike the US and European economies. The White House has not ruled out a recession for the US economy, as observed by Jared Bernstein, a member of the White House Council of Economic Advisers to the US President. The European Union is still reluctant to raise interest rates on the euro over fears of a looming recession in light of the energy crisis it is already exposed to.

The second impact is that the hike is expected to have repercussions on global stock exchanges, which suffered setbacks last week. Gulf stock exchanges will also suffer from lower stock prices, except possibly those of banks.

More rate hikes

The Fed is expected to raise interest rates twice this year once again, by 0.5 point in summer and another 0.5 point in autumn. This move will be repeated by GCC central banks, so that interest rates will reach levels that will attract more deposits. This means Gulf banks’ share prices will be in for a rise thanks to the greater growth on their net interest income in the 2022 results.

The third point is that the GCC currencies will increase against the euro and pound sterling, which is supposed to lead to a drop in imported European goods in the Gulf markets. The euro continues to plummet against the dollar – it is now at 1.05, its lowest level since 2017 – which is good news for holidaymakers from the Gulf who will spend the summer in Europe.

Remittances vs. local investments

Fourth, the foreign labour force in the Gulf will benefit from the rise in GCC currencies against their national currencies, which will lead to transferring more money abroad by leveraging the new exchange rates. This will require taking measures to open up more investment channels for this manpower within the GCC countries.

The fifth potential impact is if interest rates are raised twice more this year, prices of GCC commodity exports will increase. Such a scenario may reduce their competitiveness; but in sync with a drop in the overall import value for Gulf states. This will subsequently strengthen the balance of trade the Gulf has with key partners such as the EU, China and India.

Hence, the rise in interest rates vary between their effects on the local economy as a whole and on consumers. What needs to be done is find new ways to support the Gulf’s exports to increase their competitiveness even as their currencies rise.