Economic theory says that if your currency is pegged to another, you need to follow the monetary policy of that currency. That is why Saudi Arabia, Kuwait, the UAE and Bahrain increased their policy rates only a few hours after the central bank of the United States decided to increase interest rates by 0.25 of a percentage point last Wednesday.
That was only the first step of a process that will continue throughout next year, probably adding an additional percentage point to rates in the Arabian Gulf.
What are the implications for the GCC? In most countries, higher interest rates are frowned upon because they hamper economic growth through reduced consumption and investment. But the GCC economies are different to most countries.
When the Federal Reserve initiated its previous cycle of increases in 2004, oil was trading at US$35 a barrel, very close to today’s level. GCC policymakers and analysts back then were not worried about the rise in the classical manner.
Instead, their concern was that the deceleration in economic activity at the global level might bring an end to the trend of rising prices. Over the two previous years, prices had almost doubled, reaching an all-time high of $37 just a few days before the increase.
Their concern proved unfounded. Oil prices continued to rise, doubling again over the next couple of years. As a result, lending accelerated substantially in the region in spite of rising rates, proving that interest rates play a marginal role in the region. The analytical approach used in 2004 remains valid now. What matters in the region is the price of oil, not the interest rates.
Sentiment and government spending are the main drivers of credit in the Arabian Gulf, and both are determined by oil revenue. Household consumption has a strong correlation with salaries, in a region where the state employs most of the working nationals – about 80 per cent in Kuwait, 90 per cent in Saudi Arabia and 90 per cent in the UAE. Similarly, government deposits with local banks and state-led investment initiatives are the main driver of lending to corporations. They all depend on the capacity of the government to generate income, and oil represents 85 per cent of the regional revenue.
Sentiment also plays a central role. Without having suffered any interest-rate increase or salary reduction, consumption has started to deteriorate. October data show that withdrawals from ATMs in Saudi Arabia fell to their lowest level this year. In Kuwait, growth in household debt and transactions with debit cards has softened in the last 12 months.
The fiscal deterioration is making consumers more cautious about spending, private businesses more cautious about borrowing and banks more cautious about lending.
An additional factor explaining declining liquidity in the region is that instead of lending to businesses, banks are now lending to governments, which need money to pay the fiscal deficits that falling oil revenue has created. This is resulting in higher rates. In Saudi Arabia, the one-year interbank rate rose to a six-year high of 1.33 per cent in October.
As a result, lending in the region has been weakening since oil prices first started to decline in the middle of last year, in spite of rates at historically low levels. Lending to the private sector in Saudi Arabia declined to 5 per cent last month, the lowest rate in five years. In the UAE, the lending growth rate started to decline a year ago, going from 12 per cent in November last year to 2 per cent in July this year. Similarly, credit growth in Kuwait softened from 8 per cent to 5 per cent over the last 12 months. This trend is likely to continue.
Liquidity is going to become even more scarce and expensive, but interest-rate increases provoked by the tightening cycle in the US are not to be blamed. As usual in the Gulf, it’s about oil.
Francisco Quintana is the head of research at Asiya Investments
