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Monetary policy constraints to result in higher borrowing costs

Fiscal boosts can mitigate impact on economic growth

Image Credit: Supplied
M.R. Raghu
Gulf News

Dubai

GCC countries, with their currencies pegged to the US dollar, have limited policy options to resist Fed rate hikes. Thus, the impact of rising policy rates on cost of credit, credit growth and economic growth have to be mitigated with other policy options such as fiscal support and or macro prudential measures, according to analysts.

Historically, in most GCC countries, domestic interest rates moves in tandem with US dollar rates. Rising rates along with the rising dollar is likely to increase cost of funds for local corporates, small businesses and retail borrowers.

“A rise in interest rates on Certificate of Deposits (CDs) will attract more deposits coming into the bank relative to previous levels. Since the banks will now have to shell out additional sums in terms of higher interest rates, there is a high possibility that the interest on loans such as personal, housing, auto etc will rise as banks will try to counter the downward pressure on net interest margins. Consumers should thus subsequently expect to incur higher borrowing costs in the near term,” said M.R. Raghu, head of Research at Marmore, a fully owned research subsidiary of Kuwait Financial Centre (Markaz) and credit rating agency Moody’s.

Although the rising dollar is likely to bring some respite to imported inflation, analysts say, it could have adversely affect industries such as tourism, retail and hospitality, sectors that could become dearer because of the local currencies’ peg to the dollar.

The introduction of VAT in Saudi Arabia and the UAE at the start of the year, tightening monetary policy and higher fuel prices are widely seen as headwinds to private sector activity. The appreciation of the dollar in the second quarter of 2018 reduces the external competitiveness of non-oil, externally facing sectors.

The recent interest rate hikes by the US Federal Reserve and potential guidance of two more hikes in 2018 has adverse consequences for private sector credit growth, economic diversification efforts and economic growth of GCC countries in the year ahead and beyond.

Economists expect that with the growing optimism on US jobs and wage growth, the Fed is likely to raise policy rates two more times (four in all) in 2018 compared to the earlier forecast of three hikes.

The US rates are being pushed up by domestic factors, primarily the Fed’s balance sheet reduction and expected economic growth. However, economists predict these are likely to have unintended consequences on countries that have dollar-pegged currencies like those in the GCC.

“The current divergent economic cycles between the US and the GCC, along with lower oil prices, imply different fiscal and monetary policy needs. However, monetary policy in the GCC is determined by the exchange rate peg to the US dollar,” the Institute of International Finance (IIF), the Washington-headquartered association of leading global banks and financial institutions, said in a recent note.

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