HEIGHTENED INTEREST(S)
dubai — The Central Bank of the UAE on Thursday raised interest rates by 25 basis points for the third time this year in line with the US Federal Reserve’s decision to hike rates, paving the way for still higher borrowing costs that would have imminent implications across the financial sector.
The central bank’s move to raise its repo rate by 25 basis points as well as the interest rates on the issuance of its certificates of deposit was replicated in the same measure by other GCC central banks with the exception of Kuwaiti central bank.
Kuwait, which is the only GCC country with no currency peg to the dollar, said it is keeping its key discount rate unchanged at 3 per cent.
In a widely-anticipated decision, the Fed raised the benchmark interest rate to a range of 2 per cent to 2.25 per cent on Wednesday for the third time this year but showed no indication it would be more aggressive in efforts to head off inflation. The Fed has now raised the key rate eight times since late 2015, with one more expected in the final meeting of the year in December.
Analysts said the Fed decision comes amid worsening global trade tensions as President Donald Trump has doubled down on his confrontational stance, with
steep tariffs on hundreds of billions of dollars in goods.
Financial pundit said in the UAE the rate hike would have direct impact on both businesses and residents by raising borrowing costs in auto finance, mortgage and personal loans.
D. Ananda Kumar, chief executive for GCC operations at Bank of Baroda, said borrowing costs in the retail sector would increase in the range of 5 to 10 basis points while interest rates on customer deposits would also see a similar uptick.
“In corporate and other big-ticket deposits, the rate hike had already been factored in several days in advance in anticipation of the third hike in benchmark rates in 2018,” said Kumar. Emilio Pera, partner and head of audit at KPMG Lower Gulf, said the rate increase would escalate borrowing costs, and likely improve banks’ profitability, marking further improvement for the sector this year after the robust performance of 2017.
“The hope remains that the broader industry will absorb the higher costs buoyed by the oil price recovery and given the strong performance of loans and deposits growth in August. However, with three interest rate in- creases already announced this year, we should closely monitor any signs of stress in case of a tick up in impairments during third and fourth quarter.”
“While a fourth hike at the end of the year is widely expected, it now remains to be seen if the Fed adopts a more hawkish stance in upcoming policy reviews considering that trade tensions with China and rising oil prices are weighing on the global economic climate,” said Pera.
Most analysts are concerned that the rate increase could put further pressure on liquidity in the economy, while leading to higher borrowing costs for both governments and corporations. In particular, property and tourism sectors are going to take adverse impact of the rate hike immediately as both are cost-sensitive.
While banks will offer better deposit rate for money deposited in savings accounts and fixed deposit instruments, the hike is likely to hurt the property markets badly as the mortgage cost will see an increase. This will inevitably be reflected through a drop in demand mainly in property investment, analysts said.
They argue that higher finance rate will make properties more expensive for residents and foreign investors, while the increased cost of bank funding for projects will result in a corresponding price increase in property sector. A similar impact will be seen on automobile sales as this year’s 75 bps rise in interest is bound to negatively influence purchase decisions. While residents will have to pay more interest if they borrow, savers among them are going to earn more interest, analysts said.
The impact will be felt in the tourism sector too as a strong dirham makes the UAE less price attractive to visitors, especially those from nations of weaker currency as they have to shell more of their nation’s currency to travel to the Gulf, analysts said.
The SME sector, which depends on bank or external funding for their business operations, will also have to take the brunt of the rate hike.
Since business in the UAE is often operated with low liquidity and low margins, the higher borrowing cost may push further the margins down.
Another fallout is the increased cost of raising debt from bond markets, posing further headwinds to the already slow economic growth. Monetary tightening in the wake of interest rate hike will have counter-productive impact in the GCC economies by compounding fiscal tightening unlike in the US where the economy is on an upswing.
Financial experts contend that the Fed’s monetary policy, which is geared to the needs of the US business cycle, is not suitable for the economies of the UAE and rest of the GCC, which are currently facing a period of lower growth.
They are also of the view that adoption of tighter monetary conditions in line with the US policy would result in lower spending and investment in the GCC. This will slow down economic activity and growth prospects in the UAE, and other dollar-pegged countries in the GCC. In the past, while the dollar peg provided an anchor for GCC currencies, imposed monetary discipline and led to moderate inflation rates, it is no longer appropriate for maintaining macroeconomic stability and addressing the GCC’s growth and diversification goals, analysts said.
Exchange rate flexibility is therefore needed to address real domestic or external shocks as the strict dollar peg is counterproductive and is no longer the appropriate exchange rate regime for Gulf countries in terms of trade fluctuations or foreign inflation shocks, analysts argue.