US interest rate rise looms as ‘hindrance’ to UAE economy

The spectre of rising interest rates in the United States may be a double whammy for the economy of the UAE, which is already experiencing the fallout from lower oil prices.

The UAE dirham is pegged to the US dollar and the Abu Dhabi-based Central Bank follows the US Federal Reserve’s monetary policy. But while the world’s largest economy is on the mend, economic growth in the Emirates is beginning to slow, making rising interest rates less than ideal, observers say.

“It will be a hindrance,” said Alp Eke, a senior economist at National Bank of Abu Dhabi, the UAE’s biggest bank by assets. “With the [currency] peg regime, you have to follow their monetary policy and we need to grow. We need to actually encourage investments, to have more cash. It’s a contradictory policy.”

Most analysts maintain, however, that interest rates would need to rise markedly and oil prices would need to remain subdued for some time to make a significant impact on the UAE’s economy.

The minutes of the US Federal Reserve’s meeting last month published on Wednesday suggest that the Fed might raise rates next month after years of keeping interest rates near zero. However, market expectations are for a gradual increase.

“Obviously interest rates have been extremely low for a long period of time, so I don’t think the increase, when it happens, is going to be a surprise,” said Marc Adam, chief financial officer of the Dubai-based Commercial Bank International.

“In fact, I think it would be more of a surprise if it didn’t happen. And given that it’s anticipated, I don’t think there will be a significant impact to the UAE economy or frankly the banking sector in the short term at least.”

Mubarak Al Mansouri, the governor of the Central Bank, said this week that he expected the UAE’s economic growth to slow to 3 per cent this year from 4 per cent last year as the slump in oil prices affects the government’s ability to spend on infrastructure.

The federal government funds more than 60 per cent of its budget from the sale of crude oil, a commodity which has lost more than half of its value over the past year amid a supply glut and slowing demand from China.

Mr Al Mansouri said that interest rates on deposits would rise if the Fed started increasing rates. However, he said that UAE banks were already lifting interest rates in anticipation of that.

“I think rates are already in the system,” said Mr Al Mansouri. “They have already increased. It’s not because of liquidity. It’s because of expectations that the Fed will increase rates.”

Bank analysts agree, adding that a 0.25 per cent rate rise, which many observers reckon the Fed may start with, would be easily absorbed by lenders. More aggressive rate increases of more than 1 per cent would put pressure on borrowers at a time when economic growth is slowing.

“If the economy is robust, then the market will be able to absorb the higher rates more comfortably,” said Shabbir Malik, a Dubai-based banking analyst at EFG-Hermes, an Egyptian investment bank. “If the economy stays sluggish, then it would create credit-quality problems. The UAE would probably prefer higher interest rates when the economy is in a better shape and oil prices have started to recover.”

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