Individuals and corporates who have fixed-rate loans will stand to benefit if their rates are locked for the entire term of the loan. Image Credit: Gulf News Archives

Dubai: UAE businesses and individuals will feel the pinch of borrowing costs after the Central Bank hiked lending rates by 50 basis points (bps), matching the increase by the US Federal Reserve. Plus, a firming up in exchange rates that typically follows higher interest rates will likely weaken the competitiveness of some sectors.

The Fed’s 50 bps rate hike last week didn’t come as a surprise to UAE businesses as there had been many hawkish forecasts pegging the rate hike to be by 75 bps. In addition, some of the world’s other leading central banks - including the Bank of England and Reserve Bank of India - hiked their own lending rates, while the European Central Bank committed itself to further increases, endorsing the view that higher rates are imperative to rein in inflation.

Inflation not alarming

Forecasts say UAE’s inflation outlook is not as alarming as in the case of a number of developed and emerging economies. “The UAE is well positioned to remain robust with both oil and non-oil sectors performing well,” said Scott Livermore, ICAEW Economic Advisor and Chief Economist and Managing Director, Oxford Economics M.E.

While inflation is forecast at 2-2.5 per cent this year from 0.2 per cent in 2021, the UAE Central Bank has warned that the country is not insulated from a global inflation surge. “Soaring global inflation is a concern for open economies such as the UAE, where imported inflation would ultimately pass-through to domestic prices and feed into headline inflation,” the regulator said in its quarterly economic review.

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Rising costs for businesses

Individuals and corporates who have fixed-rate loans will stand to benefit if their rates are locked for the entire term of the loan. Those who have loans with variable rates will see an immediate jump in their interest costs. The increased cost of borrowings, at least in part, will be passed on to consumers and it is likely to dampen consumer demand.

Impact on competitiveness

The interest rate hike in the US follows a rise in the exchange rate of the dollar against other leading currencies. The UAE dirham’s real effective exchange rates, too, will strengthen by virtue of its peg to the dollar. The rising strength of the dirham along the lines of dollar could make UAE exports - including ‘deemed exports’ such as tourism, hospitality, investments in UAE asset classes such as real estate - less attractive to foreign investors because of the inflated valuations resulting from relative currency strength.

Year-to-date, the greenback has now risen more than 8 per cent against a basket of foreign currencies. On a positive note, the rising real effective exchange rate of the dirham will, to an extent, reduce the impact of imported inflation on consumer prices in the UAE.

Bank profits

The hike in interest rates will come as a big boost to the UAE’s banking sector’s profitability that suffered prolonged margin squeeze due to low interest rates. Net interest margins (NIMs) of UAE banks are expected to improve significantly from the second quarter (NIM is a measurement comparing the net interest income a bank/financial firm generates from credit products like loans and mortgages, with the outgoing interest it pays to depositors and other sources of its funding). The impact will be reflected on the profit and loss accounts of banks fairly quickly as the rate hikes take effect almost immediately on loans, while that on deposit rates could be lower and comes with a lag. Most UAE banks are well capitalised and have adequate funding. Utilising the low interest rate environment of these past two years, most banks had front-loaded their fund raising activity.

Credit growth

Analysts say a higher loan charge will push up mortgage, personal loan, and rates on funding SMEs. This along with the gradual end to the UAE Central Bank’s support to banks in June is likely to see some increase in loan defaults. “Depending on the pace and the overall amount of the increase, some clients may experience difficulty and restructure their debt,” said a senior director in financial services at S&P Global Ratings.

Many UAE banks have started notifying their customers on the increase in deposit rates to attract fixed deposits. Rates offered by banks will be a function of their funding needs and their access to other funding sources with competitive rates. “We do not expect to see a competitive rate hike in deposit products. However, small and lower rated banks are likely to offer higher rates to attract and retain deposits,” said a senior banker.