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By : Dr. Mohamed A. Ramady

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:: It is not often that countries and businesses are forewarned with near certainty on where interest rates and hence borrowing costs are heading. This is precisely what is now happening following the rise in the Federal Reserve interest rate by 0.25 per cent in March, the third time in a decade, with at least two to three more hikes forecasted along the way this year, adding another 0.75 to 1.0 percent.

These rate increases brings both losses and gains to the Gulf countries. On one hand, this should provide Gulf businesses with enough early warning to get their finances and borrowing requirements in order so as to better mange higher borrowing rates and whether to pass on costs to consumers in a more competitive economic environment.

For GCC countries like Oman, Saudi Arabia, Kuwait and Bahrain, in the process or planning to raise new or additional international loans, whether traditional bonds or Islamic sukuks, their borrowing costs and hence national debt burden is going to increase. The latest Saudi Aramco SR 10 billion sukuk issue was priced at 25 basis points above the Saudi SAIBOR rate.

It is not that the rate path is pre-set, it is just that all signals from the Federal Reserve is for a pretty aggressive quickening in pace from one to four rate hikes in a single year based on a stronger, and hence higher inflationary outlook for the US economy. On the positive side, a higher valued US dollar will reduce Gulf countries import bill, easing on foreign exchange reserve outflow.

It seems that the earlier caution of the Federal Reserve Bank and its Chair Janet Yellen has been thrown aside and gone is the almost glacial, risk-averse, once a year hikes of 2015 and 2016, replaced by the higher probability for three hikes this year and bringing to an end the near zero interest rates environment seen over the past few years. These expected rate increases are not greeted universally with dismay though, much to the relief of savers who have seen their real income decline.

It is not only the Gulf countries that face possible long term negative effects of these planned US rate hikes but many developing countries who are struggling with steep rises in their debt payments after being hit by a double whammy of lower commodity prices and a stronger dollar

Dr. Mohamed Ramady

Surprising reaction

The reaction to the rate hike and those in the planning stage has been surprising. Higher yields look to have done little to no damage, the dollar has held fairly steady, and the US stock market has soared, all of which should support aggregate demand for more growth, although the uncertainty following President Trump’s failure to muster all the Republican congress and Senate members to support his repeal of the Obamacare program has caused market uncertainty.

There could be another reason for the Federal Reserve Bank’s pre-emptive rate hikes this year. The idea is to avoid the risk of needing to raise rates too rapidly, perhaps next year when the full effects of a stimulative tax and fiscal policy are stoking demand in an economy already at maximum employment and very near mandate-consistent inflation.

The failure to pass the new Trump Medicare program will also put into doubt some of these fiscal reform measures, affecting the pace of new rate hikes. International populist political fallout is also another consideration A March interest rate move, for one, certainly resolves the potential dilemma over a May move bracketed by the first and second rounds of the French elections.

In the Gulf, the March rate hike by the US Federal Reserve has triggered similar rates by several GCC Central Banks given that their currencies are tied to the US dollar. The Saudi Arabian Monetary Authority (SAMA) raised the reverse repurchase rate from 75 basis points to 100 basis points with immediate effect, while the UAE, Kuwait and Bahrain also hiked key policy rates by 25 basis points, following the Fed rate hike.

Gulf commercial banks followed suit and hiked their lending rates with those on floating term rates hardest hit, but those who prudently took out long-term fixed loan rates better shielded, unless the banks have the right to adjust rates under fixed loan agreements granting banks this discretion.

It is not only the Gulf countries that face possible long term negative effects of these planned US rate hikes but many developing countries who are struggling with steep rises in their debt payments after being hit by a double whammy of lower commodity prices and a stronger dollar, with more pain to come. Some of the world’s poorest countries have seen the cost of repaying their debts – as a proportion of government revenue – hit the highest level for a decade.

Depleted revenues

Government revenues have been depleted by lower commodity exports, especially for countries with floating exchange rates. For commodity producers in the Gulf, dependent on oil revenues but having their currencies linked to the US dollar, the effect has been the opposite as they have benefitted from lower import prices due to the stronger dollar, although they now face higher debt repayments.

The size of dollar-denominated debts has risen as the US currency has strengthened. The dollar has risen more than 6 percent against a basket of other big currencies over the past six months as investors anticipate that big spending plans by President Donald Trump will boost US growth. This would further increase the cost of debt payments for poor countries, which have taken out big loans in recent years from western countries where interest rates have been low.

The rising cost of debt payments will put developing countries under extra strain just when they need to be spending more money at home to meet the UN sustainable development targets – a series of goals for human development intended to be achieved by 2030.

Countries with the highest debt payments in 2016 included commodity producers such as Ghana, Mozambique, Angola, Laos and Chad as well as countries on the frontline of refugee flows from Syria, including Lebanon and Jordan.

Pressure on these countries will only add to the migrant and refugee flow and continued domestic turmoil. The consequences of further US interest rate hikes are indeed far reaching.

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Dr. Mohamed Ramady is an energy economist and geo-political expert on the GCC and former Professor at King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia.

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Disclaimer: Views expressed by writers in the Column section are their own and do not reflect RiyadhVision’s point-of-view.

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