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Abu Dhabi, UAEWednesday 12 December 2018

Could you survive an interest rate hike in the UAE?

Higher borrowing costs may come as a shock to a generation more accustomed to cheap money, experts warn

Khalid Howladar, a British national and the managing director of Acreditus. Reem Mohammed/The National
Khalid Howladar, a British national and the managing director of Acreditus. Reem Mohammed/The National

Global interest rates have been close to zero for the best part of a decade, but that is now beginning to change.

The US is leading the way to higher borrowing costs, with the Federal Reserve hiking interest rates four times since 2015, and one more expected later this year.

Canada has also increased rates and the European Central Bank is thinking about tightening monetary policy. The UK would probably have acted by now, if Brexit hadn’t got in the way.

As the UAE dirham is pegged to the dollar, when rates rise in the US, they rise over here as well.

So when the Fed increased US lending rates in March and again in June, the UAE Central Bank’s response was swift, each time lifting its key lending rate by the same margin, 25 basis points. The repo rate for borrowing short-term liquidity against certificates of deposit is now 1.5 per cent.

The one-year Emirates interbank offered lending rate has now climbed from 1.48 per cent in January 2016, to a high of 2.169 per cent in July, a rise of almost 47 per cent.

This still remains incredibly low by historic standards and the pace of increases may weaken if the US economy slows as Donald Trump’s presidency loses its way.

UAE residents must still brace themselves for higher borrowing costs, because rates can only go one way from here. Those who have taken on too much mortgage, loan and credit card debt - and there are plenty - could quickly find their debt repayments unaffordable.

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Read more:

UAE Central Bank raises rates in line with US Federal Reserve

Central banks adopt a more aggressive stance

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Khalid Howladar, 43, a Briton who has been living and working in the UAE for nine years, is prepared even if rates rise faster than expected. As the managing director and founder of Dubai-based risk and rating specialists Acreditus, he has avoided the temptation many have succumbed to, of taking advantage of cheap money to load up on debt. "It’s always best to keep one's aggregate monthly expenses, including mortgage and debt repayments, to a manageable level.”

Others will be exposed if the US economy grows faster and lending rates rise higher. “It can create particular issues when the US and UAE economic cycles are disconnected, as is happening now, with the UAE economy slowing as lower oil prices hit regional spending and confidence,” says Mr Howladar.

Few central banks want to hike rates when growth is tepid but the UAE authorities will have little choice if the Fed gets hawkish. “Luckily, US inflation has unexpectedly failed to materialise, which should push out the bulk of the rate hikes to late 2017 and 2018 and oil prices have recovered a bit from their US$20 lows helping the local economy," Mr Howladar adds.

He says a generation of expats who have taken on debt since the financial crisis have never experienced higher borrowing costs, and they could come as a shock. “Given the consumerist bent and lifestyles of many expats, a mild rise in rates could quickly push them into distress.”

The UAE Central Bank has set restrictions on personal borrowing while the new Al Etihad Credit Bureau's credit scoring system should offer another layer of protection. “However given the long length of this last credit cycle some lending complacency may have set in,” Mr Howladar adds.

New regulations limiting property borrowing to 75 per cent loan-to-value have also turned down the heat. “Those who have borrowed sensibly will be fine, but those whose monthly payments are already at the maximum will face further pressure if rates rise and this is still a relatively immature mortgage market,” he adds.

As a specialist in risk management, Mr Howladar encourages prudence and anticipation of higher borrowing costs, but others seduced by the Dubai lifestyle are in greater danger.

Faisal Durrani, the head of research at the property consultants and estate agents Cluttons, says higher borrowing costs will come as a shock to a generation that has grown accustomed to cheap money. “Global rates must normalise eventually, and the UAE will not escape. Most local mortgage borrowers are on variable rates, and therefore exposed. Another 50 basis points will put people under financial stress.”

Mr Durrani says the UAE has a short-term homeownership mentality, with its transient expat population often working on fixed-term contracts. “They don't think long-term but simply opt for the cheapest mortgage, but with rates set to rise they must now plan further ahead. So consider your job security, pay rises and likely promotions. How long are you staying here? If rates are going up you must think about these things.”

Taimur Khan, a senior research analyst at Knight Frank, says the UAE residential property market looks sturdy despite the rate hike threat. “The Central Bank’s credit sentiment survey for the second quarter of 2017 indicates that credit providers are expecting demand for housing loans to increase over the next quarter, even if rates rise.”

Strong market fundamentals should counter higher borrowing costs as infrastructure investment in the run-up to Expo 2020 boosts employment and underpins demand, Mr Khan adds. “GDP growth in the UAE is expected to gain momentum to hit 2.7 per cent this year and then rise again to 3.3 per cent in 2018, supporting property prices.”

Samer Chehab, the chief operating officer at the comparison site yallacompare.com, says higher borrowing costs have had minimal impact so far. “Homeowners with variable-rate mortgages may find they are paying more every month and those applying for credit may face higher rates, but we are talking very slight increases at this point.”

However, consumers with maxed-out credit cards or near the limit of their debt-burden ratio may feel the pinch, Mr Chehab adds. "Some banks have raised their credit card rates, and given that those are calculated monthly, rather than annually, this can amount to quite a lot.”

Higher rates will be good news for savers with large sums in cash, who may finally get a return on their money, adds Mr Chebab. “Savings rates have been driven to near-zero in recent years, so any pick-up would have to be good news.

“Some banks have attractive introductory offers for their savings accounts that will give you higher interest rates on your savings for a period of time, so it’s worth investigating them. If you want a higher return, National Bonds may be the better option.”

Ambareen Musa, the chief executive and founder of Souqalmal.com, says further US rate hikes will strengthen the dollar and with it the dirham, helping those who transfer money to home countries. "The downside is that it will push up local borrowing costs so UAE residents will have to pay more for personal loans, auto loans, mortgages and credit cards.”

Your best option, she says, is to pay off debts, starting now, to ready yourself for a higher interest rate world.

Mr Musa says borrowing rates are almost always higher than savings rates, so early debt repayments make your money work harder. "When you have pay down your debts you can then switch to a high-interest account, using a comparison site to find the best deals."

A quick search on Souqalmal shows many savings accounts still pay zero per cent, or low rates of around 0.36 per cent. However, you may be able to get more, with digital-only bank CBD Now paying a variable 2.5 per cent on up to Dh500,000 for the first nine months, falling to 1 per cent thereafter.

Preeti H Bhambri, the managing director at the comparison site MoneyCamel.com, points out that rising interest rates are also positive, despite higher borrowing costs. "They signal an improving global economy, which should provide expats with better employment opportunities and higher salaries.”

She urges savers to look beyond cash to build a more balanced portfolio including exposure to stocks and shares and bonds, depending on your attitude to risk.

Higher interest rates may push up business borrowing costs and squeeze consumers, yet perversely, this may inflict little damage on the stock market.

Sam Instone, the chief executive at the fee-charging independent financial advisers AES International in Dubai, says rate hikes typically reflect a strengthening economy. “Increasing your exposure to stocks and shares could therefore make sense, depending on your attitude to risk.”

However, higher rates are bad news for investments paying a fixed rate of interest, such as bonds. “Many investors use bonds to reduce portfolio risk but a fixed rate of interest becomes less attractive as interest rates rise.”

Bond prices typically fall as a result so it may be worth reducing your exposure to fixed interest, Mr Instone says.

However, investors should resist the temptation to constantly juggle their portfolio in line with changing economic conditions, he adds. “Ignore the hype when rates rise, stay invested, and focus on the long-term. Invest in low-cost index-trackers such as exchange traded funds (ETFs) and stay the course. That is the best way to achieve long-term, consistent investment success.”

Higher interest rates do not mean the end of the world, but you still need to be ready for them anyway.