Higher oil prices to offset US interest rate's effect on GCC non-oil economy, IIF says

Washington-based institute expects region's non-oil economic growth to remain strong at 4.5% this year

The UAE flag displayed on Burj Khalifa. The IIF says higher oil prices will boost spending in the GCC. Pawan Singh / The National

Elevated oil prices will dampen the adverse spillover effect of interest rate increases by the US Federal Reserve on the non-oil economic growth in the GCC, the Institute of International Finance has said.

The extent of the effect of US monetary policy tightening on the region’s non-oil real gross domestic product is also dependent on fiscal policies adopted by the six member countries of the bloc, the IIF said in a report on Thursday.

The Washington-based institute expects the non-oil economic growth in the region to remain strong at 4.5 per cent this year, supported by an increase in public spending.

“In the past several decades, high global oil prices have more than offset the adverse growth impact of monetary tightening in the GCC,” said Garbis Iradian, IIF chief economist for Middle East and North Africa.

“High oil prices improve the domestic liquidity situation, lead to relatively expansionary fiscal policies and increase available credit to the private sector. It also puts downward pressure on interbank rates, leading to lower lending rates.”

Most central banks in the GCC follow policy rate moves by the Fed due to the peg of their currencies to the US dollar. Kuwait is an exception in the economic bloc as its dinar is linked to a basket of currencies.

On June 15, the central banks of the UAE, Saudi Arabia, Bahrain, Kuwait and Qatar increased their benchmark borrowing rates mimicking the Fed's move of raising key interest rate to control spiralling inflation and restore “price stability”.

The Fed raised the policy rate by a larger-than-expected three-quarters of a percentage point, its third interest rate increase in three months and the biggest since 1994, and signalled that more rate increases are coming.

The subsequent monetary tightening and rise in borrowing costs in the GCC came at a time when the regional private credit growth is strong — especially in Saudi Arabia, Qatar, Kuwait and Bahrain.

“We expect the policy rates in the GCC to rise further to around 3.7 per cent by year-end in line with the Fed policy rate,” Mr Iradian said.

Rising consumer prices forced the Fed to double the size of its rate increase to 50 basis points in May as it sought to curb inflation, which hit its highest level since 1981, and bring it down towards its target range of 2 per cent.

The Fed has raised its policy rates aggressively to tackle inflation that climbed to 8.6 per cent in May, a 40-year high, as Americans grapple with higher prices at the pump and in grocery stores.

However, inflationary pressure remains relatively modest in the Gulf countries. The pass through of higher global food and energy prices to domestic prices has been “limited given ad hoc price mechanisms”, the IIF said.

Inflation in Saudi Arabia was 2.2 per cent higher in May, compared with the same month in 2021. Inflation in the UAE is also relatively low. It remained at 3.3 per cent in the first quarter and is projected to average 2.7 per cent for 2022, according to the Central Bank of the UAE.

Surging oil and gas prices, exacerbated by Russia’s war in Ukraine, have fed into an already rising inflation globally.

Brent, the benchmark for more than two thirds of the world's crude, rose to a notch under $140 a barrel in March. It has given up some gains since but is still trading near or slightly more than $115 a barrel.

The elevated oil prices this year, however, will provide a boost to economic activity through additional public spending and an expansion of liquidity in banking systems in the hydrocarbon rich economic bloc.

“The impact of tighter US monetary conditions on GCC banks will also be limited, particularly in Saudi Arabia, where lenders have low levels of wholesale funding and a high level of non-interest bearing deposits," Mr Iradian said.

“Further interest rates hikes in the GCC in line with increases in the US target range for the federal funds rate could have a favourable effect on banks’ profitability.”