Analysis Economy Will latest interest hike dampen GCC’s non-oil sector recovery? By Melissa Hancock September 23, 2022 The Central Bank of Kuwait said it will raise interest rates by 0.25% to 3% from Friday 23 September Gulf oil price boost will continue to offset interest rate hikeHuge windfall for hydrocarbon-driven Gulf economies GCC non-oil sectors still expected to post strong 2023 performance GCC central banks raised their interest rates on Wednesday, in lockstep with the US Federal Reserve, raising concerns as to whether this will disincentivise borrowing in the region’s non-oil sector and result in a slowdown in the post-pandemic recovery. However, consensus among the analysts AGBI spoke to was that the impact of the current levels of tightening on borrowing appetite will be more than offset by the robust oil prices that continue to trade closely around $90 per barrel. US Fed set for big rate hike to test resilience of world’s central banksGulf central banks lift rates as Fed makes second 75-bps hike The Fed’s rise marked its third consecutive interest rate hike of 75 basis points (bps) this year. The increases that started in March – and from a point of near-zero– mark the most aggressive Fed tightening since it started using the overnight funds rate as its principal policy tool in 1990. To date, the UAE and Bahrain have mirrored the Fed’s hiking cycle (+225bps), while Oman has hiked by 25bps more. Saudi Arabia, Kuwait and Qatar have tightened less than the US. All the GCC countries have their currencies pegged to the US dollar, except Kuwait. The hydrocarbon-driven Gulf economies have seen a huge windfall this year as oil prices soared amid supply concerns – primarily due to the ongoing war in Ukraine. After expanding by four percent in 2021, the GCC’s non-hydrocarbon sector real GDP is expected to grow by 3.6 percent in 2022, considerably higher than the average 2.3 percent growth rate between 2016 and 2019, according to research provided by Moody’s earlier this month. “We have found that generally interest rates are not the largest driver of credit growth in the Gulf economies, and rather that when oil prices are elevated, as they are currently, that improves economic sentiment and also increases the scope for looser fiscal policy to boost private sector credit demand,” James Swanston, Middle East and North Africa economist at Capital Economics, told AGBI. “Since the Federal Reserve began its tightening cycle and, in turn, so did central banks in the Gulf, private credit growth for the Gulf economies has, on average, strengthened from 6.4 percent year-on-year in January this year to 7.6 percent year-on-year in May,” Swanston said. “There has been an edge down in credit growth to 7.1 percent year-on-year in June, but this is still strong by past form.” Meanwhile, Gabriele de Leva, Middle East and North Africa country risk analyst at Fitch Solutions, said: “Positive real rates could incentivise more savings. However, this will not be enough to offset the positive spillovers of the high oil price environment on investment activity through the strong role of the broader public sector.” Indeed, S&P Global Ratings expects profitability for banks across Kuwait, Saudi Arabia, Qatar, and the UAE to almost reach pre-pandemic levels by year-end 2022, spurred by high oil prices, interest rate hikes, and new public-sector-backed projects. “In the second half, we forecast a more visible strengthening of regional banks’ interest margins and a manageable pick-up in cost of risk, amid lingering effects from the COVID-19 pandemic via loans that benefited from support measures and were then restructured. Combined, these factors will be a net positive for banks’ earnings,” credit analyst Zeina Nasreddine said in a new report published on Thursday. However, GCC banks’ strong momentum so far in 2022 may not be enough to shield them from adverse developments in 2023 as expected lower oil prices –likely to average $85 per barrel next year compared with $100 per barrel for the remainder of 2022 – and potential recessions in the US and Europe next year may have knock-on effects for the region and its banks, Nasreddine concluded. Looking ahead, the expectation is that the Fed will hike rates again at its next meeting in November. Analysts expect the GCC to shadow this hike, which in turn could start to detrimentally impact the performance of the region’s non-oil economies, but that the macroeconomic outlook will remain healthy. This year’s interest rate hikes mark the most aggressive Federal Reserve tightening since 1990. It’s expected to raise rates again in November Monica Malik, chief economist at Abu Dhabi Commercial Bank, said: “Our economic forecasts already assume some dampening of credit demand and of non-oil activity in the GCC due to the fast pace and cumulative impact of interest rate hikes. “The more diversified and externally facing economies will also be impacted by the strength of the GCC currencies given the pegs to the USD and softer global growth due to the aggressive pace of monetary tightening. “Nevertheless, we continue to see the GCC in a strong economic position, supported by higher oil revenues, ongoing reforms and progress with strategic projects.” Capital Economics’ Swanston predicted that the Fed will add another 150bp of hikes in early 2023 and this will start to curb demand for credit. “However, we think that oil prices may start to fall back in early 2023 so that may factor into a possible slowdown in credit growth across the Gulf too,” he added. “This may be partially offset if the Gulf states seek to use their oil windfalls to loosen fiscal policy and drive local investment in the non-oil sectors, as has been indicated by Saudi Arabia and its future transfers to the Public Investment Fund to promote local investments in the Kingdom’s non-oil economy.” Fitch’s de Leva was also broadly optimistic about the macroeconomic outlook for the GCC, including its non-oil sectors, in 2023. “We still anticipate that most non-oil sectors in the GCC, and to a certain extent in broader MENA oil exporters, will post strong performances in 2023,” he said. He added that in the GCC, most economies will still post above-trend growth in 2023, resulting in average growth of 4.1 percent, a slight decline from 4.4 percent in 2022. Under a global perspective, growth in the GCC will slow only slightly compared to other regions in the world. GCC September interest rate hikes The Central Bank of Bahrain (CBB) was the first to announce the rate hike in the GCC. Its key policy interest rate on the one-week deposit facility is raised from 3.25 percent to four percent. The CBB has also decided to raise the overnight deposit rate from three percent to 3.75 percent, the four-week deposit rate from four percent to 4.75 percent and the lending rates from 4.50 percent to 5.25 percent. The Central Bank of the UAE (CBUAE) will raise its base rate applicable to the Overnight Deposit Facility by 75 basis points – from 2.4 percent to 3.15 percent, effective from Thursday 22 September. The CBUAE has also decided to maintain the rate applicable to borrowing short-term liquidity from the CBUAE through all standing credit facilities at 50 basis points above the Base Rate, according to a statement.Qatar has also hiked its interest rates, matching the US one by 0.75 percent. The central bank increased its lending rate to 4.5 percent, the deposit rate to 3.75 percent and the repo rate to four percent.The Central Bank of Kuwait said it will raise interest rates by 0.25 percent to three percent from Friday 23 September.