What do rising interest rates mean for Middle East business?

US Federal Reserve Chairman Alan Greenspan has increased US short-term interest rates by 0.25% to 2.75%. But his accompanying statement left little doubt that similar rate rises would now continue on a monthly basis until rates reach a more neutral level, which some economists put at 3.75%.

Mr. Greenspan noted that rising oil prices had yet to be reflected in US consumer price inflation. But this likely source of future inflationary pressure has not been overlooked by the Fed, and the prospect of higher energy prices worldwide will enhance the likelihood of interest rate rises.

Higher interest rates have the effect of cooling the world economy, and should dampen GDP growth rates from the high levels seen in 2004. The big question is whether this slowdown and adjustment can be achieved without a recession and a slump in asset prices.

The omens are not particularly good, despite the careful words of the Fed Chairman. Capital markets gear-up during periods of low interest rates, and higher rates have the opposite effect.

ABN Amro has warned its clients that higher US interest rates might result in a sell-off of European equities as recent buying has been financed with cheap dollar borrowings. If nothing else this is a reminder how inter-linked global capital markets have become.

For the Middle East the main threat from higher interest rates is a recession in the oil consumer countries which would dramatically lower demand for oil and produce a rapid fall in oil prices. This would lead to a liquidity crunch in the oil countries, although the vast pools of liquidity after four years of high oil prices would act as a cushion.

If nothing else the rush to invest in new real estate projects and IPOs might start to come to an end. This would have a detrimental impact on associated businesses. Also a recession in the oil consumer countries might impact on GCC tourism as such discretionary spending would be hit.

Many economists believe a recession and higher interest rates would also lead to a strengthening of the US dollar, as a recession would tend to correct the trade deficit and relieve the pressure on the US dollar which is handling it alone at the moment. Again this has serious implications for Middle East business that is mainly done in US dollar pegged currencies.

A more difficult point is whether a recession and the inevitable consequent falls in equity and real estate prices in the oil consumer nations would hit GCC stock and realty valuations. The answer is possibly not initially, as more investment might come into local assets instead of going abroad, but the longer term impact is harder to quantify.