Gulf set for more belt tightening as interest rates keep rising

Creative Commons/Saudi Scoop

• Borrowing costs for both businesses and consumers will rise
• US Federal Reserve expected to introduce further rate rises
• High oil prices cushion Gulf from recession fears in Europe and US

The Gulf’s business owners and consumers are set for tougher times ahead as the region’s central banks followed the US Federal Reserve and increased interest rates on Wednesday.

While experts predict that rate hikes are set to continue even further, many analysts believe that the combination of strong GDP growth and high oil prices will help to cushion the Gulf from the worst of the recession fears in Europe and the US.

The central banks of Saudi Arabia, the UAE, Qatar and Bahrain mirrored the policy of the US Fed and increased their interest rates by 75 basis points (bps) to three percent, 1.65 percent, three percent and 3.25 percent respectively.

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Kuwait, which is the only economy that does not have its currency pegged directly to the US dollar, but to a basket of currencies, raised its rate by 25 bps to 2.5 percent.

“This means borrowing costs for both businesses and consumers will rise, which is likely to slow domestic demand,” said Khatija Haque, chief economist and head of research at Emirates NBD, Dubai’s biggest bank.

“However, headline GDP growth in the GCC will be boosted by sharply higher oil and gas production this year.”

Passing on costs

The latest S&P Global UAE Purchasing Managers’ Index (PMI), published earlier this month, found that rising energy costs and higher wage bills were biting into profit margins, as most UAE companies opted to not increase prices in order to remain competitive.

That said, a poll by Female Fusion, a UAE-based community of female entrepreneurs, found that 60 percent of respondents said they planned to raise prices in the coming months. 

Keren Bobker, a Dubai-based independent financial advisor and senior partner at Holborn Assets, said the move by the central banks will make price increases more likely.

“An increase in interest rates will lead to an increase in costs for many businesses, as well as for individuals. Ultimately, we’ll see a further increase in prices and in inflation,” she said.

The combination of rising prices and more expensive credit is not good news for consumers.

Research firm Euromonitor International’s recent forecasts predicted that consumer expenditure will grow by 3.2 percent in the UAE and 8.3 percent in Saudi Arabia in real terms this year, compared to 1.3 percent and 10.2 percent, respectively, in 2021.

“Further rises in interest rates in the region, moving with the Fed, may undermine Gulf consumers’ willingness to borrow and spend towards the end of this year, affecting private consumption,” said Lan Ha, Euromonitor’s head of practice – economies.

The increase in the cost of financing is also likely to put a dent in businesses’ expansion planes, according to Iain Ramsay, chief investment officer at financial services firm AHR Private Wealth.

“From a business perspective, those companies with expansionary plans may look to press pause and re-evaluate when faced with an increased cost of capital or may shelve plans entirely until they are comfortable interest rates are not likely to rise further,” he said.

“The Gulf region does, however, have a slightly unique set of circumstances in that the economies benefit greatly from high oil and gas prices.

“With many businesses and individuals benefitting from these higher prices the region could prove more resilient than others due to this dynamic.”

Mortgage misery

One group who will be directly impacted are mortgage buyers. Anyone on a variable rate mortgage will see their monthly payments increase.

“As few employees are getting salary increases, the real cost will be exponentially higher,” Bobker said. 

However, she added that “we have had low interest rates for so long that many people have either forgotten, or are unaware, of the historical averages, which are far higher than we have seen for 10 years.”

The Dubai property market, in particular, is mainly cash-focused and Faisal Durrani, partner and head of Middle East research at real estate advisory firm Knight Frank, pointed out that mortgaged buyers for villas and apartments at present account for just 18 percent of the value of the Dubai residential market.

“Last year, the figure was nearer 40 percent and in 2007 just over 50 percent of transactions were financed. This is not necessarily a reflection of a reduction in mortgage lending, but the high volume of cash purchases is overshadowing the mortgage market, which to an extent reduces the risk to the residential market,” he said.

Property developers will also be impacted by the rate hike, as they will find it more difficult to get project financing or re-finance at viable rates. 

“Banks will want a clear indication that any projects are still clearly profitable at the higher levels of interest. Good banks will also be increasing their default projections, so may scale back the amount of high risk lending they wish to take on at this point in time,” AHR Private Wealth’s Ramsay said.

More to come

While many groups will be feeling the pinch from Wednesday’s news, the interest rate hikes look set to continue for some time.

“I believe the Fed will continue on a path of further rate rises – pulling back to a 50 basis point hike in September, and will then stay between 25 and 50 basis points for the subsequent two meetings this year,” said Randall Kroszner, professor of economics at the Chicago Booth School of Business, and a member of the US Federal Reserve Board of Governors from 2006 to 2009.

On a brighter note, France-based Jamil Naayem, principal economist at S&P Global Market Intelligence said this ongoing monetary policy tightening, coupled with local currency appreciation, is likely to help tame inflationary pressures across Gulf economies.

“We currently forecast average annual consumer price index growth in the GCC to rise from 2.1 percent in 2021 to an 11-year high of 3.9 percent this year, before moderating to 2.9 percent in 2023, as global commodity prices ease back from recent highs,” he added.

Looking for some optimism in the rate gloom, Steve Drake, managing partner at AHR Corporate Advisory Services and a board director at the British Business Group Dubai and Northern Emirates, said it may force businesses to review their costs and become more efficient.

“We often find that with market catalysts such as interest rate movements, they provide an opportunity for businesses to take a fresh look at their cost base,” he said. “There are generally always savings to be made with the right lens applied.”