Complex Made Simple

Fitch: GCC hikes show peg commitment; oil still key for growth

GCC central banks will seek to broadly maintain the spreads between their policy rates and the Fed funds rate

Interest-rate increases by the central banks of Saudi Arabia (AA/Negative), Bahrain (BBB-/Negative), and Kuwait (AA/Stable) reflect their commitment to their exchange-rate pegs and are not the result of immediate market pressures, Fitch Ratings says. Higher policy rates will contribute to slower non-oil growth in the region, but their effect on economic activity will be minor compared with the dampening effect of lower oil prices.

The 25 basis point rate hikes, in line with the decision of the US Federal Reserve, are consistent with our assumption that GCC central banks will seek to broadly maintain the spreads between their policy rates and the Fed funds rate. As Fitch highlighted in its MENA Sovereigns Outlook, the dollar pegs of these countries are important anchors of economic policy. Since 2009, the policy rate spread has been around zero in Saudi Arabia, 25bp-50bp in Bahrain, and 180bp-230bp for Kuwait.

We expect non-oil activity to slow across the region, as lower oil prices weaken domestic confidence and compel governments to rein in spending plans. We forecast GCC median real credit growth to fall to 4% by 2017 from over 8% in 2014, with non-oil growth dropping to around 4% in 2015-2017 from 5% in 2014. This reflects spillovers from lower hydrocarbon prices and not higher interest rates.

We expect policy rates to rise only gradually, and although banks will raise lending rates (boosting their profitability), the increases will not be large enough to meaningfully affect aggregate demand for loans in 2016. Nevertheless, the combination of more expensive credit and more frugal governments will prevent a return to the growth rates of 2010-2014, when non-oil economies expanded at a real rate of 6% per year in the GCC on average.

The forward discounts at which Gulf currencies are traded against the US dollar have recently increased but are still low at around 2%, implying no devaluation expectations that could put pressure on reserves. At 3.6 months of current external payments, Bahrain’s international reserve coverage ratio in 2015 is the lowest among Fitch-rated GCC sovereigns, but it is above its own long-term average of two months. Reserve coverage will be ample for the other GCC countries, reaching as high as 25.6 months in Saudi Arabia.

For all Fitch-rated GCC oil exporters other than Bahrain, vast accumulated buffers give them time to make (mostly fiscal) adjustments. At an oil price assumption of USD 55/b for 2016, we expect Saudi Arabia to post fiscal and current account deficits of around 10% of GDP and 5% of GDP, respectively, but it will still have estimated sovereign net foreign assets (SNFA) of around 100% of GDP. Bahrain has a negative SNFA position and an expected general government deficit of 10% in 2016, but we expect its current account to remain roughly balanced. We expect the SNFA positions to remain high for Qatar (150% of GDP), Abu Dhabi (200%) and Kuwait (450% of GDP).