GCC economies set to loosen purse strings to boost growth
MONETARY POLICY WILL CONTINUE TO REMAIN FOCUSED ON PRESERVING CURRENCY PEGS
After going through three years of fiscal tightening, GCC economies are once again loosening their purse strings to support non-oil economic growth in the context of rising interest rates, slowing credit demand and private sector loan growth.
According to analysts, for most GCC economies the recent rise in oil prices and the savings made through last two years of fiscal consolidation will come handy in lending support to the economy.
The GCC’s monetary policy will continue to remain focused on preserving the currency pegs to the dollar in the context of rising US interest rates.
Last week, the US Federal Reserve raised interest rates by 25 basis points 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.
Going forward, GCC interest rates will be raised further as US rates are expected to rise.
The Fed raised its policy rates seven times in the cycle that began in December 2015, with a tightening move each quarter since the end of 2016.
Tightening to continue
Economists expect the tightening cycle to continue the US economic data relating to unemployment and inflation supporting further rate tightening.
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.
“We expect another two rate hikes, each of 25 basis points, for the rest of this year and three hikes in 2019. We also expect the Central Bank of Oman to raise its repo rate in coming weeks. However, the Central Bank of Kuwait, is likely to maintain its discount rate at 3 per cent,” said Garbis Iradian, chief economist for the Middle East and North Africa (Mena) at the Institute of International Finance (IIF).
Short-term US and GCC interest rates move in tandem, as the region’s currencies (except the Kuwaiti dinar) are pegged to the dollar, and the borrowing and deposit rates are usually higher in the GCC then those in the US.
However, the spreads between the 3-month interbank rates in Saudi Arabia, the UAE and the US have narrowed. As of June 14, the spread was 12bps between Saibor (Saudi Arabia Interbank Offered Rates) and Libor (London Interbank Offered Rates), and 2bps between Libor and Eibor (Emirates Interbank offered rates).
Policy compulsion
GCC central banks have policy compulsion to avoid negative spreads between their respective interbank rates and Libor to reduce the risks of capital flight. In addition, a tighter monetary policy will weigh on non-oil economic activity.
“The timing of monetary tightening and the rise in borrowing costs is coinciding with continued weak economic activity and a sharp slowdown in bank lending, due to weak consumer and government-related enterprise spending, as well as reduced confidence,” said Boban Markovic, an analyst at the IIF.
Despite the policy challenges, analysts say the GCC has ample fiscal space to tide over the policy challenges to economic growth.
“We see growth picking up as the expansionary fiscal stance offsets the losses from monetary tightening. Real GDP growth in the GCC is expected improve to 2.2 per cent in 2018 [from a contraction of 0.3 per cent in 2017] and 2.7 per cent in 2019, driven by a substantial increase in public spending and a gradual increase in oil production, particularly in Saudi Arabia,” said Iradian.