The UAE Central Bank in Abu Dhabi
The UAE Central Bank in Abu Dhabi. With the GCC currencies pegged to the dollar, most central banks in the region instantly followed the Fed and cut their key policy rates. Image Credit: Gulf News Archives

Dubai: The recent interest rate cut by the Federal Reserve is expected to boost private sector credit growth and credit demand in key GCC economies, according to economists.

GCC central banks, with the exception Kuwait, announced interest rate cuts following the 25 basis points interest rate cut by the Federal Reserve last week. With the GCC currencies pegged to the dollar, most central banks in the region instantly followed the Fed and cut their key policy rates. Kuwait — the only GCC country with a basket-pegged currency — kept its policy rate on hold.

Monetary easing is expected to make borrowing cheaper for investors across key GCC economies. Private sector credit growth in Saudi Arabia is accelerating, reaching 2.7 per cent year on year in June 2019, after dropping to negative territory in 2017 and early 2018.

Gross credit growth in the UAE accelerated 0.7 per cent month on month and 4.3 per cent year on year in June according to the latest central bank data. The strongest monthly growth in credit was from the government related entities and private businesses. Year to date (YTD) data in the UAE showed private businesses’ credit growth has moderated from end-2018, while retail has contracted by 1.5 per cent YTD.

Cost of funds

Economists said lower rates are expected to incentivise borrowing especially private corporate and retail borrowings. “Lower interest rates will make credit more available to the private sector and provide a window of opportunity for companies to refinance loans at a lower cost. Despite lower oil prices, liquidity conditions in the region still look healthy except Oman,” said Garbis Iradian, Chief Economist, Middle East and North Africa, Institute of International Finance (IIF).

A pick up in private sector credit growth is expected to lift the non-oil private sector growth in the region which suffered during the past 5 years largely due to persistent fall in oil prices compounded by higher cost of funds that resulted from monetary tightening.

“While more accommodative monetary policy conditions may give a boost to business activity, continued low oil prices and political tensions within the region may limit the improvement in business confidence,” said Boban Markovic, senior research analyst at the IIF.

Although lower interest rates are supportive of credit growth, economists said apart from cost of funds, credit demand will largely remain a function of overall economic conditions that affect business confidence.

“Lower interest rates are positive for reducing debt-servicing costs, though we are cautious on the potential additional support to credit demand with the economic headwinds,” said Monica Malik, chief economist of Abu Dhabi Commercial Bank.

Fund flows

Interest rate cuts combined with some softening of the dollar could boost inflows into emerging markets, including to the GCC. With lower interest rates, both governments and private sectors will have an opportunity to tap capital markets at a lower cost.

Despite a potential positive impact on loan growth analysts expect lower interest rates to adversely impact profitability of banks due to margin compression. “We expect higher pressure on the net interest margins of the GCC banks, especially those with a higher focus on consumer lending,” said Iradian.