Fed loosening cycle may not be such a big fillip to Gulf

Andrew Kelly/Reuters

The Gulf states have duly followed suit in mirroring the decision by the Federal Reserve to cut benchmark interest rates by 50 basis points.

This is the first cut in four years and the more economically supportive of the two options in front of the US central bank.

The Gulf countries are required to import monetary policy from the US by virtue of their dollar pegs. The so-called “impossible trinity” means that, because of a commitment to fixed exchange rates and the free movement of capital across borders, interest rates in the Gulf have to follow the Federal Open Market Committee.

In theory, if the central banks in the Gulf do not mirror the Fed, abnormally strong inflows may put upward pressure on exchange rate pegs. 

But the core policy objective of Gulf central banks is to ensure stability, so they have followed the Fed. Interbank interest rates closely track those in the US, albeit with a spread reflecting a premium demanded by investors to hold local currency instead of dollars.

There are now two main macroeconomic channels to focus on. 

Households will be less likely to save as returns decline, which should lift consumption

The first is lower debt servicing costs. Households and businesses will be able to refinance or take on new loans at a lower interest rate which, at the margin, may ease fears in banking sectors of rising non-performing loans.

Admittedly, the extent to which loans are on variable or fixed interest rates is hard to gauge due to a lack of data. But the IMF has suggested that, in the case of Saudi Arabia at least, loans are largely variable and therefore borrowers are likely to benefit as rates come down.

The second affects the incentives to save and borrow. Households will be less likely to save as returns decline, which should lift consumption. At the same time, demand for credit should, in theory at least, rise as the cost of borrowing is lower.

However there are reasons to think that this may not lead to an expected improvement in domestic credit growth. For one thing, interest rates are likely to remain high by past standards. 

This Fed loosening cycle will not take interest rates down to the lows of 2009-16 or the levels seen during the Covid-19 pandemic.

What is more, credit growth in the Gulf economies has tended to be influenced more by the level of oil prices rather than the direction of monetary policy. Over the past 15 years, when oil prices have fallen below $80 per barrel, credit growth across the Gulf has tended to weaken. 

• Gulf central banks mirror US Federal Reserve rate cut
• US Fed cuts will not prevent an oil-price crash in 2025
• US rate cuts will help Gulf bonds but oil worries persist

The reason for this trend is that, during periods of higher oil prices, fiscal policy in the Gulf is more supportive and, in turn, non-oil sectors perform better. Not only does this encourage households and businesses to borrow due to greater confidence, but banks are also more willing to lend as they believe there is a greater likelihood that debts will be repaid.

The price of Brent crude is currently at $74 per barrel and unlikely to rise much in the near future, particularly if Opec+ increases supply in December. As a result, we would not be surprised to see credit growth in the GCC slow, even as the Fed cuts.

Moreover, lower oil prices are likely to result in budget balances in the Gulf deteriorating. Fiscal policy may then become less supportive and cause some states to turn to austerity measures. As a result, it looks increasingly likely that growth in non-hydrocarbon sectors will soften over the coming years.

Interest rate cuts are helpful to economic growth, but in the Gulf oil prices are the greater driver of prosperity.

James Swanston is Middle East and North Africa economist at London-based Capital Economics