Interest rate hike in UAE to bolster dirham

The Central Bank of the UAE on Thursday joined its peers in Saudi Arabia, Kuwait, Bahrain and Qatar to raise benchmark interest rates within hours of the US Federal Reserves's decision to increase US rates by a quarter point to 0.75 per cent, a move that analysts say may hamper efforts to boost economic growth.

The UAE central bank raised interest rates applied to its certificates of deposits, which are the monetary policy instrument through which changes in interest rates are transmitted to the UAE banking system.
The strengthening dollar makes the UAE dirham and other Gulf currencies, which are pegged to it, stronger. This, in turn, will further make the tourism, retail and real estate industries more expensive to traditional customers from Europe, India and Russia, financial experts said.
Vineet Kumar Dudeja, chief executive for GCC operations at Bank of Baroda, said following the rate hike, dollar Libor (a benchmark rate that some of the world's leading banks charge each other for short-term loans) across maturity has already gone up in anticipation.
"Since the dirham is pegged to the dollar, the Eibor (Emirates Interbank Offered Rate) has also moved upward over the period more or less in tandem."
Dudeja said the move has increased the cost of borrowing in the UAE interbank market. "Thus bidding for UAE central bank CDs will be on higher rate. A decision on the Repo rate will depend on macroeconomic factors of the UAE, including oil price's expected movement in addition to further US rate hikes," said Dudeja. Analysts said because of an increase in US interest rates at a time when the Reserve Bank of India has embarked on cutting interest rates, there is a high chance that rupee will depreciate.
Although, this will make India more competitive in exports, because of slowdown, India has not been able to take advantage of the situation. Being an importer of crude oil, a depreciating rupee will add pressure on inflation, they said.
Tim Fox, head of Research & Chief Economist at Emirates NBD, said the UAE Central bank's move to raise interest rates on Certificates of Deposit is consistent with similar moves in other GCC countries and with the regional currency pegs that exist to the US dollar. "Firmer interest rates and the accompanying strength of GCC currencies are likely to be further headwinds to regional growth in 2017 as monetary policy is effectively tightened, coming on top of recently announced OPEC cuts in oil production as another factor likely to weigh on activity next year."
"A stronger currency makes it harder to attract capital, makes the region's non-oil exports less competitive and makes it harder for domestically produced goods to compete at home with ever cheaper imports," said Simon Williams, HSBC Holdings Plc's chief economist for central and Eastern Europe, the Middle East and North Africa.
Monica Malik, chief economist at Abu Dhabi Commercial Bank, said the rate hike in GCC banks would complicate efforts to bolster economic growth and ease a cash squeeze among Gulf banks as revenue from oil exports, the region's main source of income, plummets.
"At a time of tight liquidity and slowing economic activity this is going to be additional headwind to the situation, especially if you see more frequency in interest rate hikes. This is going to be something that will affect the region," said Malik.
The long anticipated Fed move comes after it quietly ended its Quantitative Easing efforts in October 2015. This effectively ends almost a decade worth of a steady and ultra loose monetary policy that was initiated to fight the ravages of the 2008 financial crisis.
"Higher oil prices will be a boost to budgets across the region," said  Khatija Haque, head of Mena research at Emirates NBD. "The deficits are going to fall without the government needing to cut expenditure. The balance of payment is going to improve as well because of higher oil revenue."
Analysts said while the US Fed raised borrowing costs to counter rising inflation expectations as the economy accelerates and unemployment dips below five per cent, Gulf countries, on the other hand, face slower growth and a cash squeeze in the banking system. Governments have slashed spending and curtailed state largess. Oil prices have rebounded, but revenue remains lower than levels seen before 2014.
The prospect of more increases in US rates next year will further complicate efforts to bolster economic growth and ease a cash squeeze among Gulf banks as revenue from oil exports, the region's main source of income, plummets, they pointed out.
The projected three rate increases next year would be followed by another three increases in both 2018 and 2019 before the rate levels off at a long-run "normal" 3.0 percent. That is slightly higher than three months ago, a sign the Fed feels the economy is still gaining traction.
How Gulf stock markets reacted to the rate hike
Reuters
Most major Middle Eastern stock markets fell on Thursday after the US central bank raised interest rates but buying by local retail investors lifted Saudi Arabia.
In Dubai, the index slid 0.8 per cent to 3,554 points. Heavyweight Emaar Properties dropped 2.2 per cent and its retail affiliate Emaar Malls Group tumbled 4.4 per cent. Qatar's index lost 1.3 per cent.
Saudi Arabia outperformed, rising 0.4 per cent, although trading volume shrank further to a moderate level and many banks and petrochemicals favoured by institutional investors were sluggish.
Egypt's index was almost flat as Orascom Telecom, the most heavily-traded share, rebounded four per cent.
issacjohn@khaleejtimes.com