Understanding the Impact of Federal Reserve Interest Rate Changes on Gulf Markets:

Decisions made by the Federal Reserve regarding interest rates have far-reaching effects on both the domestic and global economy, including in the Gulf region. In light of ongoing speculations about the stability of GCC economies following any upcoming interest rate changes, FOREX.com’s analysts are shedding light on how such changes could potentially impact regional markets, including the UAE.

Before delving into possible effects, a brief explanation of interest rate dynamics would help better understand market movements and trends.

When the Federal Reserve lowers interest rates, it stimulates economic activity by encouraging borrowing and spending, potentially leading to job creation. When interest rates are raised, the Federal Reserve aims to control inflationary pressures and prevent overheating in the economy. Such changes have a direct impact on the US Dollar: as interest rates rise, foreign investors find it more appealing to hold US Dollar-denominated assets, which leads to an increased demand for the green currency and strengthens its value.

GCC countries, such as the United Arab Emirates and Saudi Arabia, have their currencies pegged to the US Dollar to ensure stability and facilitate international trade and investment. 

As a result, the UAE and GCC central banks typically follow the lead of the US Federal Reserve when it comes to interest rate adjustments. Therefore, when interest rates go up, the UAE and GCC central banks often take similar actions to prevent capital flight to countries offering higher yields. This synchronized approach helps local governments maintain capital flows and confidence in the currency pegs, while preserving the region’s overall economic stability, attracting foreign investments, and managing inflationary pressures. 

According to Ritu Singh, FOREX.com Regional Director says: “In the UAE, interest rates play a crucial role in shaping the business environment. The common belief is that higher interest rates strengthen the UAE dirham, benefiting importers, but negatively affecting exporters, as a stronger currency makes exports more expensive and less competitive in international markets. As a result, exporters may face challenges in maintaining their market share.”

“Higher interest rates can also lead to increased borrowing costs, impacting sectors, such as real estate and construction. Moreover, a strong currency negatively affects tourism and hospitality as tourists tend to favor destinations with weaker currencies, since they become more affordable. Manufacturing industries can experience difficulties, too, as the cost of capital or funding increases with higher interest rates, potentially impacting investment and expansion plans.”, added Singh.

In a recent World Bank report, analysts highlight that the frequency of financial crises increases as interest rates rise, affecting various aspects of the financial sector. In extreme cases, the debt burden could consume a significant portion of the country's revenue, like in Nigeria, who had to pay 96% of its revenue on debt servicing in 2022.

Yet, such dreadful scenarios may remain rather far-fetched in the Gulf, considering the proactive approach of countries like UAE and KSA, who are constantly adjusting their strategies, goals and plans to balance their currency’s peg to the US Dollar and their unwavering commitment to maintain their respective financial systems’ stability.