Benchmark interest rates in the Gulf are slated to be increased twice this year and thrice in 2019 but the expansionary fiscal stance offset the losses from the monetary tightening, which is to weigh more on the non-hydrocarbons, according to the Institute of International Finance (IIF).
"We expect another two rate hikes, each of 25 basis points, for the rest of this year and three hikes in 2019," said the Washington-based economic think tank.
Key policy rates have increased by 25 basis points in Saudi Arabia, the UAE, Qatar, and Bahrain following the recent hike in the US as the monetary policies in the Gulf Co-operation Council (GCC) remains focused on preserving the currency peg to the dollar.
The short-term US and GCC interest rates move together, as the region’s currencies are pegged to the dollar and the borrowing and deposit rates are usually higher in the GCC than those in the US.
Expecting tighter monetary policy to weigh on non-oil economic activity; the IIF said the timing of monetary tightening and the rise in borrowing costs is coinciding with continued weak economic activity and a sharp slowdown in bank lending on weak consumer and sovereign-related enterprise spending as well as lower confidence.
"However, we see growth picking up as the expansionary fiscal stance offsets the losses from monetary tightening," it said, adding real GDP (gross domestic product) growth in the GCC is expected improve to 2.2% in 2018 (from a 0.3% contraction in 2017) and 2.7% in 2019, driven by a substantial increase in public spending and a gradual increase in oil production, particularly in Saudi Arabia.
The IIF said higher oil prices this year have provided space for GCC authorities to boost government spending after three years of fiscal consolidation.
Finding that the GCC yields track those in the US, it said elevated US treasury yields and a stronger US dollar sparked a selloff across several emerging economies and pushed yields higher over the past few months.
"The modest GCC bond outflows in March and April are likely to be temporary as GCC bonds offer solid risk-adjusted returns and foreign investors’ exposure is limited," it said.
The GCC bond prices fell in May, in line with the ongoing selloff in emerging markets (EM) assets, it said, adding however, the sovereign spreads remain lower than most EMs as government financing needs have eased with higher oil prices.
The IIF found that pressures on the GCC currencies in the forward market have eased, unlike several EM currencies. These reflect higher oil prices and stronger fundamentals in the GCC (including low debt and large financial buffers (in the form of official reserves and sovereign wealth funds).
"In this setting, we see no significant pressure on the peg against the dollar," it said.
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