GCC fol­lows Fed rate hike to avert cur­rency pres­sure

KAMCO ECO­NOMIC RE­PORT

Kuwait Times - - BUSINESS -

The Fed­eral Re­serve raised the fed funds rate for the first time in 2016, by 25bps on 14-De­cem­ber to a range of 0.50 per­cent - 0.75 per­cent from a range of 0.25 per­cent - 0.50 per­cent, as eco­nomic data and la­bor mar­ket con­di­tions re­port­edly strength­ened. The Fed up­dated their eco­nomic pro­jec­tions over 2016-19 and for the longer run, high­light­ing op­ti­mism by im­prov­ing fore­casts for real GDP, em­ploy­ment and in­fla­tion. Faster pace of rate hikes are ex­pected in 2017 (3 hikes), as against Septem­ber-16 ex­pec­ta­tions (2 hikes), but pol­icy stance con­tin­ued to re­main ac­com­moda­tive.

GCC states hike rates

Fol­low­ing the an­nounce­ment of a Fed rate hike, GCC states also raised their bench­mark rates, given the pegs of their coun­tries to the US dol­lar. Saudi Ara­bia raised its re­verse repo rate to 0.75 per­cent, while keep­ing its repo rate at 2.0 per­cent. The Cen­tral Bank of Kuwait lifted its dis­count rate by 25bps from 2.25 per­cent to 2.5 per­cent, while the UAE raised rates on its cer­tifi­cates of de­posits by 25 bps. Bahrain and Qatar also raised key in­ter­est rates by 25bps to 0.75 per­cent. The overnight in­ter­bank of­fered rates of UAE, Kuwait and Qatar rose as a re­sult.

Stronger dol­lar

The USD con­tin­ued to scale multi-year highs lead­ing up to the Fed event, and even post the rate hike, a trend that is ex­pected to con­tinue in 2017, as more risk-off trades un­fold. Mean­while, a strength­en­ing USD did dampen the rise in oil prices re­lated to the ex­pected re­duc­tion in out­put, but we ex­pect prices to sus­tain above the $ 50/bbl level. Given the ex­pec­ta­tions of fur­ther fu­ture rate hikes, KAMCO Re­search ex­pects bonds to rel­a­tively un­der­per­form other as­set key as­set classes over the medium term, as yields fall, while the per­for­mance of eq­ui­ties would be more based on cor­po­rate earn­ings, rather than liq­uid­ity driven, as seen in the past. Rate hikes adds to GCC’s chal­lenges; but cur­rent ac­count surplus now a pos­si­bil­ity Fur­ther rate hikes may add to the ex­ist­ing chal­lenges for the GCC in terms of lower growth, the re­cent cut in oil out­put and bud­getary con­straints, as higher bor­row­ing costs are likely to make its way through to cor­po­rates and con­sumers via higher in­ter­bank rates. How­ever, we now ex­pect the fis­cal deficit in 2017 be lower than the 6.9 per­cent of GDP fore­casted by the IMF, as higher oil prices post the out­put cut trans­late into ad­di­tional rev­enues. Also KAMCO Re­search now sees a re­turn to cur­rent ac­count surplus in 2017 as plau­si­ble for the re­gion, as against the deficit of 0.5 per­cent of GDP fore­casted by the IMF, as bal­ance of trade terms could im­prove if higher oil prices sus­tain and USD strength per­sists, lead­ing to lower im­port bills for the re­gion.

Medium term ex­pec­ta­tions

Post 2017, the Fed does see the pos­si­bil­ity of bench­mark rates in the US reach­ing above 3 per­cent, to an up­per end of the range of 3.4 per­cent by as early as 2018, whereas the longer term rates post 2019 could inch up to 3.8 per­cent on the higher end. Av­er­age ex­pec­ta­tions of pol­i­cy­mak­ers have been pushed up from 2017 on­wards by 20-30 bps as com­pared to their Septem­ber16 meet­ing. The me­dian ex­pec­ta­tion by the end of 2017 is at 1.4 per­cent as com­pared to pre­vi­ous ex­pec­ta­tion of 1.1 per­cent. Sim­i­larly, the av­er­age rate pro­jec­tion for 2018 is 2.1 per­cent, up from 1.9 per­cent in Septem­ber16. Real GDP growth on the other hand was re­vised up­ward by close to 10bps in 2017 and 2019, while leav­ing 2018 un­changed, and is ex­pected to av­er­age close to 2 per­cent p.a. over 2016-19.

Saudi Ara­bia’s move to keep the repo rate un­changed was likely to en­sure that liq­uid­ity in the bank­ing sec­tor was still com­fort­able, and to mit­i­gate in­ter­bank lend­ing rates from steeply ris­ing, in our view. The Cen­tral Bank of Kuwait also guided that the move to hike rates in re­sponse to the Fed’s rate hike was to en­sure the con­tin­ued com­pet­i­tive­ness and at­trac­tive­ness of the na­tional cur­rency as a store of do­mes­tic sav­ings. Bor­row­ing costs for Kuwait are likely to rise by about 11 per­cent, ac­cord­ing to our cal­cu­la­tions. How­ever, even as overnight in­ter­bank rates rose, the 3-month in­ter­bank rates ex­hib­ited mixed trends as Saudi Ara­bia, Kuwait and Qatar rates rose, while the rate in the UAE de­clined from 1.4029 per­cent to 1.3336 per­cent, as banks would have likely re­leased funds on softer terms. Though some cen­tral banks have kept the lend­ing rates un­changed in re­sponse to the rate hike in the US in or­der to keep the liq­uid­ity in their economies com­fort­able, fu­ture rate hikes would even­tu­ally re­flect on in in­ter­bank rates and even­tu­ally lead to higher bor­row­ing costs in the re­gion.

Mar­kets are on risk-off mode

Post the Fed’s de­ci­sion, the mar­ket saw typ­i­cal risk-off trades as emerg­ing mar­kets and com­modi­ties bar­ring oil wit­nessed de­clines, if sin­gle day re­turns were an­a­lyzed. MSCI GCC in­dex was down as well, al­beit marginally by 0.2 per­cent.

Oil re­mained re­silient and range bound inch­ing up marginally by 0.2 per­cent post the event. The USD in­dex con­tin­ued its move up since Septem­ber 2016 and to­wards the lead up of the rate hike, and was up by 1.2 per­cent fol­low­ing the rate hike as well. Re­turns for US trea­suries un­der­stand­ably de­clined as yields fell, and are likely to re­main un­der pres­sure go­ing for­ward. De­vel­oped eq­uity mar­kets in the US, UK and Euro re­gion gained as in­vestors pre­ferred to move safer havens.

We con­tinue to ex­pect that, GDP growth in the GCC re­gion would bot­tom out in 2016, and im­prove in 2017 as higher oil prices would off­set pro­duc­tion cuts, and in­ter­na­tional fund­ing ini­tia­tives would be in­cre­men­tally pos­i­tive for state bud­gets and fu­ture rev­enues. We ex­pect them to con­tinue to tap the in­ter­na­tional bond mar­ket in 2017, even as Kuwait de­cides to en­ter the mar­ket, af­ter 2016 wit­nessed Saudi Ara­bia rais­ing $17.5 bil­lion in a triple tranche of­fer­ing, along with Qatar ($9 bil­lion) and Abu Dhabi ($5 bil­lion). How­ever, though we re­main op­ti­mistic about the mea­sures taken so far by the GCC states, the rollover of sev­eral global risks leaves more room for em­ploy­ing ad­di­tional ini­tia­tives to boost non-oil pri­vate sec­tor growth. En­ergy sub­sidy ra­tio­nal­iza­tion and tax re­lated ini­tia­tives such as VAT are seen as in­cre­men­tally pos­i­tive in our view. In­fla­tion re­mains well within the ideal range as well, al­though prices are ex­pected to in­crease at a slower pace than in 2016, from 3.6 per­cent to 2.6 per­cent in 2017, as per the IMF. Nev­er­the­less, we see a lot of mov­ing parts both glob­ally in terms of risks, and re­gion­ally in terms of po­ten­tial for higher rev­enues and bet­ter man­age­ment of state fi­nances, which hold the GCC’s out­look in the com­ing year at a bal­ance, in our view.

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