Report urges caution over monetary policy

GCC policy-makers must “remain vigilant” in carrying out their monetary policy in the wake of increased risks posed by an unstable global economy, analysts said.

Bahrain’s Gulf Finance House (GFH) in its GCC Economic Outlook for 2008 said it expected the global economy to record a slower growth rate despite conditions improving in the credit markets in recent months.

“Our outlook for the GCC economy continues to be very positive but the increased risks to the global economy mean that policymakers in the GCC have to remain vigilant, especially in the conduct of monetary policy,” said GFH Chief Economist Dr Ala’a Al Yousuf, author of the report.

With regard to exchange rate policies in the GCC, the investment bank said the dollar is expected to weaken further against the euro to around $1.55 in the next few months before making a partial recovery, meaning the main adjustment in the dollar’s value has already taken place. “Speculation about a possible concerted one-off revaluation of the currencies of the GCC4 [excluding Kuwait and Oman] could return in the next few months,” the report said.

However, the investment bank added that the issue is unlikely to be decided under market pressure.

“The US faces a prolonged period of lower growth rate than its potential, as the macro-economic imbalances and financial conditions gradually adjust towards sustainable levels.

Nonetheless, other major economies, such as the euro-zone and Japan, have not seen the same excesses, and should hold up reasonably well,” he said.

“The rapidly developing economies of Asia in particular, led by China and India, should be able to de-couple at least partially from the US, as they have done before,” Dr Ala’a said. 

Gulf Finance House said the key risk to the GCC this year is spillover of slower growth in the US to global demand for crude oil, and consequently crude oil prices. However, the report said oil prices are expected to drift lower towards $75 per barrel by mid-year  as increased supply catches up with weakening demand and the dollar stabilises  and then pick up again in the second half of 2008.

GCC-wide oil and gas export receipts are expected to top $450 billion in 2008, almost $12,000 on a per capita basis, according to GFH.

The external current account surplus is also forecasted to hover around $200bn and the fiscal surplus is expected to be in the range of $150bn to $170bn.

According to the report, these surpluses are expected to boost government expenditure  smoothing capabilities over the medium term  and to finance the spree of cross-border acquisitions by sovereign wealth funds.

The second key risk to the GCC is “stubbornly high inflation”, given the very limited scope for the use of monetary policy, Gulf Finance House said.

However, inflationary pressures are expected to moderate this year. “Global inflation fears are now overdone, and will not prevent major central banks from responding to the downside risks to growth by cutting interest rates,” it said.

The report added that in the baseline scenario, the US Fed would slash the Target Fed Funds rate to 2.5 per cent by mid 2008.

GCC states have already cut policy interest rates in response to the sudden Fed rate cuts on January 22 and January 31, and more cuts are expected to follow.

According to GFH, GCC governments are most likely to step up the use of sterilisation operations via issuing central bank bonds/certificates of deposit, as well as direct credit/price controls.

These include caps on loan-to-deposit ratios, higher reserve requirements, subsidies, and caps on rental increases. The investment bank predicts inflation rates will hover above the five per cent mark across GCC, mostly driven by increases in housing rents and food prices.

It expects real estate prices to stay firm as delays in project delivery, rises in construction costs, an inflow of expats and growth in mortgage finance heighten imbalances in supply and demand.