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Fed turns more hawkish, GCC economies will require fiscal support

Rising rates combined with strengthening dollar to hurt economic growth

Image Credit: Ahmed Kutty/Gulf News Archives
Gulf News

Dubai: The US Federal Reserve on Wednesday raised interest rates as widely anticipated. GCC countries (except Kuwait) with their currencies pegged to the US dollar have announced further rate hikes tracking the Fed rates, implying an automatic tightening of monetary policy.

Analysts expect two more rate hikes this year, implying higher cost of funds for GCC borrowers.

“We have now seen seven rate hikes in the cycle that began in December 2015, with a tightening move each quarter since the end of 2016 (including the reversal of quantitative easing in September last year). The “dot plot” now points to four rate hikes in total in 2018 (compared to three before), with another three in 2019 and one in 2020,” said Richard Jerram, Chief Economist of Bank of Singapore.

The rate hike trajectory appears incremental and is largely justified by economists based on the US economic data relating to unemployment and inflation. The Fed expects the US unemployment rate to be below the target and inflation above the target by the end of this year, warranting a relatively hawkish approach to rates, going forward.

Monica Malik“The communication related with the Fed’s June meeting was hawkish, suggesting two further rate hikes of 25 bps in 2018 and three in 2019. This will lead to a further tightening in monetary policy in the GCC at a time when economic momentum remains soft. A loosening in fiscal policy will remain vital in supporting the GCC growth outlook,” said Monica Malik, Chief Economist of Abu Dhabi Commercial Bank.

The UAE Central Bank said on Thursday that it was raising its repo rate by 25 basis points to 2.25 per cent and increasing interest rates on certificates of deposits by the same margin.

The move came after the US Federal Reserve decided to raise its target range for the federal funds interest rate by a quarter of a percentage point, to between 1.75 per cent and 2 per cent.

On Wednesday, Saudi Arabia’s central bank also said that it was increasing its reverse repo rate, the rate at which commercial banks deposit money with the central bank, by 25 basis points to 2 per cent from 1.75 per cent. It also raised its repo rate, at which it lends to banks, by 25 basis point to 2.5 per cent.

Bahrain’s central bank also raised its key policy interest rate by 25 basis points. The interest rate on the one-week deposit facility was raised to 2.25 per cent from 2 per cent, while the overnight deposit rate was raised to 2 per cent from 1.75 per cent.

Qatar’s central bank said on Thursday that it was raising its deposit rate by 25 basis points to 2 per cent. Meanwhile Kuwait’s central bank said on Wednesday it will maintain its discount rate unchanged at 3 per cent.

Rising interest rates combined with the strengthening dollar could mean some headwinds for the GCC economies that faced deeper than expected economic slowdown in 2017. In the GCC, overall GDP fell by 0.2 per cent last year, with Saudi Arabia witnessing its first economic contraction since 2009. The International Monetary Fund (IMF) in its latest regional economic outlook has revised growth outlook downward for most GCC countries.

Relative to the forecasts in the October outlook, with the pickup in oil prices, prospects for oil exporters have improved somewhat with a positive revision to 2019 IMF growth outlook.

While the expiration of the output cut deal by Opec and its allies this year, combined with a slower approach to fiscal reforms, is expected to boost growth from the end of this year, rising interest rates could pose challenges to cost of funds for many GCC countries that have been heavily dependent on market funding to bridge fiscal deficits.

Interest burden

Although public debt remains manageable for most GCC oil exporters, the rapid build-up of debt in some of them is a cause for concern, according to the IMF. Debt has increased by an average of 10 percentage points of GDP each year since 2013, with countries financing large fiscal deficits through a combination of drawdowns of buffers and increased domestic and foreign borrowing.

Looking ahead, several factors are likely to continue to drive debt upward for GCC countries. These include the slower pace of fiscal consolidation, weak growth prospects, and the possibility of higher financing costs given the expected monetary policy tightening in advanced economies.

Given anticipated financing needs — cumulative overall fiscal deficits of the oil exporting countries from the region are projected to be $294 billion in 2018-22, while cumulative government debt amortizations amount to $71 billion for the same horizon — countries are increasingly vulnerable to a sudden tightening of global financial conditions.

An additional amount of $312 billion of nongovernment-issued international debt (of which almost 40 per cent corresponds to state-owned enterprises) is coming due over the next five years.

“The fiscal impact these debts could be larger if along with the rising interest rates, these countries also experience a sudden stop in international market access that leads to a materialisation of fiscal contingent liabilities,” said a recent IMF report.

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