Fed hike: Is it in your interest?

Dubai - If you are a borrower, you're going to pay more interest

The second US Federal Reserve rate increase in three months by 25 basis points on Wednesday will have an immediate impact in the dollar-pegged Gulf countries where cost of borrowing and cost of doing business will escalate.
In other words, the common man will have to pay higher rates of interest on his personal loan, auto loan, housing finance and credit card transactions.
In short, if you are a borrower, you're going to pay more interest; if you're a saver, you are going to get a little more interest.
However, with the dirham becoming stronger, prices of imported goods, including gold, mobile phones, electronics and home appliances will slightly come down. For expatriates, a stronger dirham means more attractive remittance rate against their home currency.
If the US Fed hikes rates two more times this year, as is widely expected, consumer's borrowing cost will go up by 100 bps or one per cent.
In other words, on a Dh100,000 bank loan, a consumer will end up paying Dh1,000 more annually.
US Fed officials indicated in December that three rate hikes would be likely for 2017. After the March 15 hike, June and December as the most likely time for rate increases.
In the UAE's real estate sector, such rate increases will result in higher cost of bank funding for projects, leading to a corresponding price increase from the side of developers in addition to rising mortgage rates.
Given that higher rates may reduce borrowing and spending, sectors such as restaurants and shopping malls that depend heavily on consumer discretionary spending may suffer. Higher rates may also force companies to slow down their hiring plans, analysts said.
For those planning on buying a property or a car, a half percentage rise in interest, will have much impact.
Most credit cards on the market have a variable rate, which means there's a direct connection to the benchmark rate. A half-percentage-point rate hike means a credit card rate will go up by as much within the next billing cycles.
Vineet Kumar Dudeja, chief executive for GCC operations at Bank of Baroda, said in three months between December 14, 2016 and March 15, 2017, bank interest rates in the UAE and other GCC countries have risen by a corresponding 50 bps following US rate hikes, making bank finances more expensive.
"For the common man, this means higher borrowing costs whether it is on his personal or car loans, credit card or housing finance. For GCC governments and large corporates, such rate hikes will escalate the cost of raising debt from bond market at a time of lower oil prices."
Almost immediately after the US Federal Reserve increased the interest rate by 25 basis points, a number of central banks in the GCC, including the UAE followed suit as they have been pressured by the need to protect their currencies even though an economic slowdown in the region calls for loose monetary policy.
Abbas Basrai, partner for financial services at KPMG Lower Gulf, said the currency peg of the dirham to the dollar means that local interest rates have to be aligned to those of the dollar.
"The key question is how many further increases in the interest rates will there be this year? The indications are that there could be two more rate hikes in 2017," said Basrai. Pradeep Unni, head of trading and research at Richcomm Global Services DMCC, said the immediate impact would be a spike in the borrowing costs across the financial sector which includes, auto loan, mortgage loans and personnel loans.
"Economically speaking, this rise in rates during the time of lower oil prices will only add pressure to the government to bring liquidity to the economy. This ideally means that both governments and corporations will pay more to raise debt from bond market," said Unni.
Basrai said there are several factors that drive the move for two more rate hikes. These include targeting inflation at two per cent; getting the unemployment rate under control and attaining a "normalised" interest rate. "Financial services firms are generally being squeezed by ultra-low interest rates and the potential creation of asset bubbles due to a prolonged period of low interest rate. In our view, a return to normal interest rates justifies more increases in the US Fed's interest rates and consequently in the GCC."
"For borrowers, it will become important to differentiate between existing customers and new borrowers, variable and fixed rates. An existing borrower with a fixed rate will see no impact whereas one with a variable rate will see the cost of servicing the financing going up by the rate increase," said Basrai .
All new borrowers will see the cost of servicing the financing go up too. A majority of the UAE banks have their own standard variable rate that they use to price a new transaction. The Fed rate hikes, which result in the local central banks raising their rates, obviously have an impact on the standard variable rate, said Basrai.
Another direct impact of the hike could be in the tourism sector.
"Travellers from countries of weaker currency will have to shell out more of their currency to travel to the Gulf. Rising borrowing costs can also hurt the SME sector that depends on banks or external funding for their business operations," said Unni.
- issacjohn@khaleejtimes.com