The United States Federal Reserve hit pause on its plan to gradually withdraw monetary support for the economy, prompted in part by growing concerns about the trade war between China and the United States as well as the worrying global macro picture, offering an opportunity for Gulf Cooperation Council (GCC) countries to also ease credit conditions in the face of debt financing needs burdens, low oil prices, and subdued growth expectations.
Following the Fed’s decision to lower the federal funds rate in July, trade tensions have escalated between the world largest economies, with an agreement unlikely anytime soon. The heightened uncertainty surrounding trade policy, and its dampening effect on business sentiment and investment, means the U.S. central bank is likely to cut short-term interest rates again when it meets on September 17-18.
Five GCC nations peg their currency to the U.S. dollar (Kuwait pegs to a basket of currencies), insulating them from wild currency swings while limiting their ability to conduct independent monetary policy – their central banks’ monetary policies have to move in lock-step with the Fed.
The GCC is a political and economic bloc made up of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. When the Fed’s policymaking body, the Federal Open Market Committee (FOMC), raised rates, most GCC central banks followed the U.S. central bank’s move by also reducing target interest rates. Saudi Arabia, Bahrain, and Qatar lowered their official lending rates, while deposit rates were dropped in the UAE and Kuwait.
This fixed currency regime protects them against undue fluctuations in their exchange rate while easing sovereign borrowing conditions for countries with weaker macroeconomic fundamentals – such as Bahrain and Oman.
Non-oil Sector A Bright Spot In GCC Economic Outlook
Economic growth in the region is not expected to be much faster compared to 2018, held back by lower oil prices, limits on oil production, and slowing global growth.
While the International Monetary Fund’s updated World Economic Outlook, released in July, did not include revised growth projections for GCC countries, it forecasted economic activity in the Middle East, North Africa, Afghanistan, and Pakistan region to be 1 percent in 2019, 0.5 percentage point lower than in the April WEO. This is largely due to growing concerns about the impact of geopolitical tensions – such as crippling sanctions on Iran, and conflicts in Syria as well as Yemen.
Lower interest rates will also support non-oil sector activity across the GCC, at a time when the governments of these countries continue to prioritize boosting private sector investment. This will help offset the reduced contribution from the oil sector due to OPEC production cuts and weak global demand.
For example, IMF does see “improved prospects” for the region’s largest economy – Saudi Arabia – with its non-oil sector is expected to strengthen in 2019 on the back of higher government outlays and improved confidence
Global Easing of Financing Conditions Fuels GCC Debt Issuance
In 2018, as the Fed raised interest rates and dialed back monetary stimulus measures, interbank rates rose in the GCC as policymakers tightened policy in tandem with the U.S. – making credit more expensive and slowing economic activity in the region.
This impacted regional financial hubs such as Dubai, which does not have the oil wealth of UAE powerhouse Abu Dhabi and relies on more debt financing, and Bahrain, whose banking sector plays a central role in fueling economic activity.
Now, the easing in global financing conditions sparked by the Fed may counterbalance higher risk premia for GCC sovereign debt from geopolitical concerns and drops in oil price, while also allowing for more debt issuance.
Following the Arab Spring, many GCC countries embarked on massive spending sprees to prevent any outbreaks of public unrest within their borders, with estimates of $150 billion spent collectively on housing and social projects in the first half of 2011 alone.
Since then the focus has shifted to significant investments in their respective non-oil sectors, with many also tapping bond markets to fund their expenditures, which placed a substantial strain on government budgets.
The plunge in benchmark global bond yields due to ongoing trade tensions, central bank easing and signs of slowing economic growth has encouraged GCC borrowers to tap the debt market. GCC bond issuance hit a record $40 billion in Q2 of this year, breaking the previous high of $32 billion reported in Q1. Bonds were issued primarily by sovereigns and state-backed entities to fund strategic investments as well as rollover maturing debt at a lower rate.
Even cash-strapped Oman, who has a junk credit rating from all three agencies, successfully raised $3 billion on the international debt markets in July.
GCC nations are expected to continue issuing domestic and international debt this year, with global and regional borrowing costs already low and likely to decline further, capitalizing on investors’ hunt for yield.
Lower interest rates should provide some breathing room for policymakers to maintain support for domestic economic activity while having room to navigate external uncertainties such as bouts of oil price volatility, which the IMF predicts “are likely to persist in the near term.”