With fears about Greece exiting the euro having abated, the focus of global markets has quickly returned to the US Federal Reserve, with the markets bracing for an interest rate hike as early as next month.
Regionally, this will also have an impact through currencies that are largely pegged to the US dollar, causing local interest rates gradually to push higher as well. Such a prospect adds to concerns that already exist about the regional economic outlook, principally related to the decline in oil prices and the impact of recent fiscal consolidation steps.
The IMF highlighted these in its latest Article IV Consultation Paper for the UAE published last week. In it, the IMF said that “lower oil prices are eroding fiscal and external surpluses, and going forward a hike in the US interest rate could lead to a tightening of financial conditions”.
The IMF also lowered its growth outlook for this year to 3 per cent from the 3.2 per cent forecast it made in April, and significantly lower than the actual 4.6 per cent growth last year. The IMF also indicated that recent spending cuts announced by the UAE government will cut 1 per cent off annual economic growth between now and 2020.
So far, however, from what we have seen this year, the economic data does not yet appear to support such a sharp pace of slowdown. The reason for the latest GDP forecast adjustment appears to be mainly the oil sector, as the non-oil growth projection was left unchanged at 3.4 per cent. However, so far at least, oil production has actually increased in the first half of this year, according to Bloomberg estimates, with average output in the period 2.4 per cent higher than the average for last year. Unless there is a sudden decline in oil output in the second half, it is likely that the oil sector will continue to contribute positively to growth this year.
Turning to the non-oil sector, there has certainly been a slowing in the growth momentum over the course of the year, but not a reversal.
The Emirates NBD UAE Purchasing Managers’ Index has shown a gradual softening in the UAE’s non-oil activity since last October. However, the latest reading showed activity rising to 55.8 last month, from 54.7 in June. And having averaged 56.8 in the first seven months of the year, the PMI has been reflective of a relatively solid pace of growth overall. So while the economy probably has slowed, the degree to which this is happening remains open to question.
And even if growth does fall by as much as the IMF is forecasting, it would still represent a superior outcome to many other parts of the world. In emerging markets for example, China is slowing sharply, and Russia and Brazil are in recession.
Also relative to many developed economies, the UAE’s PMI is continuing to demonstrate a relatively strong performance overall. The UAE’s reading, for example, compares very favourably with the JP Morgan Global Manufacturing PMI, which has been stuck at about 51.0 for the past four months. In fact, considering the challenging regional and global macroeconomic backdrop, the latest PMI survey highlights resilience within the UAE economy, with the 1.1-point improvement in the headline reading relative to June the strongest monthly PMI gain in nine months.
Into this mix, a prospective tightening of US monetary policy should not necessarily be viewed too pessimistically. Rather, normalisation of US monetary policy should be taken as a positive development as far as the US economy is concerned, and may even be beneficial regionally as well as in other parts of the world.
The world has been waiting for the Fed to lift interest rates for too long now, with the consequence that many investment decisions have not been taken, or put on hold. Sentiment has too often been clouded by the uncertainty of what is happening in the United States, such that consumers and businesses have become paralysed by the fear of what is around the corner.
Beyond the initial shock impact of US interest rates being raised for the first time since 2006, the removal of that uncertainty should actually incentivise companies and individuals to take risks and galvanise growth, not damage it.
Tim Fox is the head of research and chief economist at Emirates NBD.
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