The U.S. Federal Reserve's Impact on Gulf Economies: What Investors Need to Know
As the U.S. Federal Reserve gears up for a loosening cycle, Gulf economies are set to feel the ripple effects. According to a recent note from Capital Economics, Gulf central banks will likely follow the Fed's lead due to their dollar pegs and open capital accounts.
While lower interest rates may provide some relief in terms of debt servicing costs, the overall impact on growth in the Gulf is expected to be limited. Capital Economics predicts that the Fed will cut the fed funds rate by 25 basis points at the September policy meeting, with further cuts totaling 200 basis points by the end of 2025. This will prompt Gulf central banks to lower their own rates in line with the U.S.
The "impossible trinity" principle dictates that Gulf interest rates must mirror those in the U.S. due to fixed exchange rates and free capital movement. As a result, interbank interest rates in the Gulf closely track those in the U.S., albeit with a premium for holding local currency.
The looser monetary policy will impact the Gulf in two main ways. Firstly, lower interest rates will reduce debt servicing costs for businesses and households, potentially easing concerns about non-performing loans. Secondly, lower rates will influence saving and borrowing incentives, with households likely to save less and borrow more.
However, Capital Economics warns against expecting significant credit growth, as historical data suggests that oil prices, rather than interest rates, drive borrowing in the Gulf. With oil prices currently at $72 per barrel and not expected to exceed $75 in the near future, the boost to credit growth may be limited.
In conclusion, while the Fed's loosening cycle will bring lower interest rates to the Gulf, the broader economic impact is expected to be restrained. Non-oil GDP growth may slow as fiscal policy becomes less supportive in the coming years.
Analysis: The Federal Reserve's decision to lower interest rates will have a mixed impact on Gulf economies. While it may provide some relief in terms of debt servicing costs and borrowing incentives, the overall economic growth is not expected to see a significant boost. Investors in the Gulf region should be cautious about expecting a major upturn in credit growth, as historical trends suggest that oil prices play a more significant role in driving borrowing behavior.