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Higher interest rates to have limited impact on GCC economies: IMF

18 Dec 2022 By GULAM ALI KHAN

Muscat – GCC central banks have raised their policy rates many times this year following sharp rate hikes by US Federal Reserve which adopted an aggressive monetary policy tightening programme to tame the record high inflation.

Central bank policy rates in the GCC countries mostly follow US policy rates given the pegged exchange rate regimes, with implications for the overall economy and the banking sector.

However, an analysis conducted by the International Monetary Fund’s (IMF) staff has found that the US monetary policy tightening would have a limited impact on the non-oil economy and the banking sector of the GCC including the UAE, Saudi Arabia, Oman, Qatar, Kuwait and Bahrain.

“GCC central banks raised their policy rates following the US federal funds rate and further hikes are expected in line with the US monetary policy tightening cycle.Our analysis finds that US monetary policy tightening would have a limited impact on the non-oil economy and the banking sector in an environment of high oil prices and liquidity,” the IMF said in a report.

Monetary policy rates in the GCC countries tend to move in line with the US federal funds rate. Since the start of the pandemic, most GCC central banks have moved their policy rates broadly in line with the US Federal Reserve, which is consistent with previous US tightening and easing cycles. The banks’ liability and asset rates also tend to move strongly with policy rates.

“In most GCC countries, a banking structure with low wholesale funding and a large share of non-interest-bearing deposits is expected to improve banks’ net interest margins, particularly as corporate sector borrowing is at variable rates reset every three to six months,” the IMF said.

The IMF staff’s analysis indicated that further monetary policy tightening is likely to have a limited impact on non-oil GDP growth, banks’ profitability, credit growth and asset quality in the GCC in a high oil price environment that increases liquidity in the system.

Historically, non-oil GDP growth in the GCC appears to be more sensitive to US monetary tightening episodes when oil prices are low, the IMF noted. The level of oil prices – through its effect on domestic liquidity – could potentially dampen or amplify the impact of nominal policy rate changes on non-oil GDP growth, it added.

The primary objective of monetary policy in the GCC countries is to ensure their exchange rate stability. Monetary policy is anchored by the fixed exchange rate of the national currency to the US dollar. The exchange rate pegs are maintained by managing the magnitude of short-term interest rate differentials with US interest rates.

As per the IMF, pegged exchange rate regimes remain appropriate for GCC economies despite global economic volatility and shocks.

“It is a policy that has been serving GCC countries well by providing a credible monetary anchor. However, the pegs should continue to be reviewed regularly to ensure they remain appropriate and do not hinder competitiveness,” the IMF added.

The IMF said that, historically, there has been a limited impact of monetary policy tightening episodes on credit growth in the GCC in periods when oil prices were high.

Despite tightening episodes during 2004-2007, credit growth in the GCC countries remained strong as oil prices were at relatively high levels, the IMF noted.

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