Dubai: The Central Bank of UAE (CBUAE) and Saudi Monetary Authority (SAMA) announced quarter of a per cent (25 basis points) cut in their key lending rates with effect from Thursday, following the much-anticipated rate cut by the Federal Reserve.
GCC central banks in general follow the Fed’s monetary policy lead to maintain exchange rate stability in their respective countries in the context of their pegged currencies. This time too, regional central banks, with the exception of Kuwait, were expected to cut rates following the Fed action. Kuwait, usually does not follow the Fed rate cuts as its currency is pegged to a basket of currencies.
The CBUAE announced that effective Thursday 19 September 2019, it will lower interest rates on certificates of deposits (CDs) in line with the decrease in interest rates on US dollar. The repo rate applicable to borrowing short-term liquidity from CBUAE against CDs has also been decreased by 25 basis points. The SAMA too announced 25 basis points cut in both repo and reverse repo rates.
The Fed rate cut comes at a time when leading Gulf economies, especially Saudi Arabia and the UAE, are facing slower growth in the context of regional geopolitical challenges and external headwinds ranging from trade war, lower oil prices, slower global growth and exchange rate appreciation.
Economists expect lower interest rates to work in favour of Gulf economies as it is expected to reduce cost of funds and boost borrowings to support flagging GDP growth.
The UAE has been facing slowing credit growth combined with rising real effective exchange rates, hurting growth prospects of key non-oil sectors such as real estate and wholesale and retail trade. Lower rates are widely expected address both these concerns to some extent.
“Further monetary easing would make borrowing cheaper for investors, since lower US interest rates could put downward pressure on the dollar and thus make dirham denominated properties more affordable. Weakness in the wholesale and retail trade and construction sectors continues and further appreciation of the dirham real effective terms is hurting key sectors such as real estate, trade and tourism,” said Garbis Iradian, Chief Economist, Middle East and North Africa of the Institute of International Finance (IIF).
Although markets have been anticipating more Fed rate cuts this year, Fed put out a hawkish tone following the latest round of rate cuts.
“During his press conference, Fed Chair Powell focused on projecting optimism about the economy, and reiterated that the Fed stands ready to ease further to sustain the expansion if needed. While he again cited global growth and trade conflict as risks to the expansion, there was a conspicuous lack of commitment to further cuts — which signals a data-dependent approach ahead,” said Eli Lee, Head of Investment Strategy, Bank of Singapore in a note.
While markets are left less certain (on rate outlook) due to Powell’s less dovish than expected press conference, the slowing economic growth outlook for the US and the rest of the world is likely to bring more pressure on the Fed to revisit the rate decision in the third quarter.
“We continue to expect one to two more 25bp cuts from the Fed over the next 12 months as structural risks persist while investor sentiments would ebb and flow over this period,” said Lee.
GCC policy options
Amid Fed’s seemingly hawkish outlook on future rate cuts, GCC countries, particularly the UAE and Saudi Arabia has fiscal space to spend their way to boost their non-oil economic growth.
“The UAE can afford a modestly expansionary fiscal stance in the next few years given its large financial buffers and spare capacity,” said Jonah Rosenthal, Associate Economist of IIF.
While lower rates are expected to reduce borrowing costs of companies and individuals analysts are not sure it that alone is enough to increase credit growth to private sector.
“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 ADCB in a recent note.
Latest CBUAE data shows, gross credit expanded by 0.7 per cent month on month in July for the second consecutive month, its strongest pace seen so far this year. Annual gross credit growth accelerated to 5.1 per cent year on year in July on the back of the monthly expansion, up from 4.3 per cent year on year in the previous month. However data showed private businesses’ credit growth steadily decelerated to 4.3 per cent from a recent high of 7.5 per cent year on year in October 2018.
What rate cut means for GCC
Lower debt burden and borrowing costs for individuals and companies
Likely to boost private sector borrowings
Lower local currency rates to check appreciation of Dirham against dollar and support demand for real estate, wholesale, retail and tourism