Rising oil prices to trump rising rates for GCC economies

Higher crude oil prices to fuel government spending

Higher oil prices to fuel GCC growth this year despite rising interest rates. Zohaib Anjum/Getty Images

The spectre of economy-cooling rising interest rates in the Arabian Gulf will be tempered by the ability of governments around the region to spend more this year and the next amid rising oil prices, according to economists.

“If the oil price remains at the current level, there could be some additional increase in government spending - above our current forecasts,” said Monica Malik, chief economist at Abu Dhabi Commercial Bank.

“This will be positive for supporting domestic demand, especially at a time of rising interest rates.”

Ms Malik said that any additional fiscal support from governments is likely to come at the end of 2018 or 2019 as they define the areas of spending during Ramadan and the quiet summer months. She also noted that there were already signs of strengthening investment activity in the UAE.

The renewed optimism comes as the price of oil hits highs not seen since 2014 amid decline in both supplies and production as well as a rise in geopolitical tensions after the US pulled out of the Iran nuclear deal in May. Brent crude touched $80 a barrel on May 17 and is up 15 per cent year-to-date.

However, one of the main risks to economic growth in the region this year is rising interest rates. The fact that most Gulf states peg their currencies to the US dollar and as a result follow its monetary policy means the majority of the region will continue raising interest rates along with the US Federal Reserve.

Standard Chartered is forecasting that the Central Bank of the UAE will raise rates four times this year and twice next year, taking the benchmark interest rate to 3.25 per cent by the end of next year. Higher interest rates may deter businesses and individuals from tapping the debt markets and subdue economic growth at a time when credit growth is already lacklustre.

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The rising strength of the dollar may also pose some problems for the economy. The Bloomberg dollar spot index, a measure of the US dollar against 10 other currencies, is up 1 per cent this year.

While a stronger dollar is good for expats in the country, because they get more for their greenback, overall it is not great for the economy. The strengthening dollar does not help countries in the region that are most diversified, like the UAE which rely on investments into assets including real estate, stocks and bonds as well as other goods and services like tourism. A stronger dollar makes tourism from countries like Russia and India pricier for visitors.

“Although we forecast further rate hikes by GCC central banks, we also expect oil prices to average $71 a barrel in 2018, a significant increase over last year,” said Bilal Khan, senior economist for the Middle East North Africa and Pakistan at Standard Chartered.

“This will allow GCC policymakers to increase spending without compromising budget deficit targets.”

The non-oil economies of the GCC have been in growth mode over the past year. Bahrain’s real gross domestic product advanced 3.9 per cent in 2017 compared to 3.2 per cent in 2016, with the non-oil economy expanding 5 per cent, according to Bahrain Economic Development Board. The gains were led by growth in tourism, figures from the latest Bahrain Economic Quarterly released earlier this month showed.

The oil exporting economies of the Arabian Gulf expect to see a pick-up in GDP growth in 2018 and 2019, after bottoming out last year, as the price of oil rebounds and non-oil business activity recovers, according to the International Monetary Fund.

However, the fund warned uncertainty about the direction of oil prices, growing global trade tensions, geopolitical risks and rising interest rates made the need for economic reforms more urgent.

The gross domestic product of oil exporters in the Middle East and North Africa grew on aggregate 1.7 per cent in 2017 compared to 5.4 per cent in 2016, and is expected to rise 2.8 per cent in 2018 and 3.3 per cent in 2019, the fund said. Economic growth in the GCC contracted 0.2 per cent overall last year and Saudi Arabia, the Arab world’s largest economy, went into recession for the first time since 2009. GCC economic growth is expected to rise 1.9 per cent in 2018 and 2.6 per cent in 2019, the IMF said.

The rise in the GCC is due not only to a resurgence of oil prices but also to higher spending after years of austerity aimed at narrowing the fiscal deficit. The improvement of government finances through the reduction of subsidies and, in the case of Saudi Arabia and the UAE, the implementation of 5 per cent VAT in January is also helping plug the shortfall. Governments also tapped global bond markets to raise funds in the wake of the 2014 oil crash, which helped keep infrastructure projects ticking despite some delays. Saudi Arabia also embarked on a wide-ranging reform programme that included a campaign against corruption and a plan to sell stakes in state assets, including a 5 per cent stake in Saudi Aramco, the world’s largest oil producer.