Impact of rising interest rates
After more than a decade of low interest rates, the end of pandemic lockdowns triggered a sharp rise in inflation globally, prompting central banks worldwide to respond by raising rates from nearly zero to over 5%.
The US Federal Reserve, for instance, raised rates from 0.25% in early 2022 to around 5.25% by mid-2023, one of the most significant increases in decades.
The Fed’s move compelled GCC central banks, whose currencies are typically pegged to the dollar, to lift rates in lockstep even though inflation in the region was not as pronounced as in other parts of the world.
This increase in interest rates has made borrowing more expensive – whether for mortgages, car loans or business growth – as governments have sought to reduce inflationary pressures by cutting consumer and commercial spending.
Higher rates have helped GCC banks record $53.2bn of cumulative net interest income since 2021, as they have benefited from larger margins between the rates they offer to depositors and those charged to borrowers.
The total assets for banks increased from $2.86tn in the second quarter of 2022 to $3.3tn around the same time in 2024, reflecting consistent expansion during the period. Conventional banking assets grew from $2.1tn to $2.4tn, while Islamic banking assets rose from $768bn to $903bn.
The banking sector’s total net profits grew by 12% year-on-year (YoY) in Q2 2024, reaching $3.3bn, up from $2.9bn in Q2 2023. For the first half of 2024, sector profits rose by 13.9% YoY to $6.5bn, compared to $5.7bn in the same period of 2023.
This growth in total and segment-specific banking assets has been accompanied by a significant rise in liquidity across the sector.
According to the Central Bank of the UAE, the banking sector’s liquid assets rose to AED786.6bn ($214.2bn) by the end of Q1 2024, marking a 28.2% YoY increase, or AED172.8bn more than the AED613.8bn recorded in Q1 2023.
Amid this increase in liquidity, the broader economic landscape in the region is also showing signs of steady growth. According to World Bank data, economic growth in the GCC reached 0.7% in 2023 and is expected to pick up to 2.8% and 4.7% in 2024 and 2025.
Projects landscape
While banks have benefited to some extent from higher interest rates, non-financial sectors have had to reassess their borrowing strategies, particularly in the projects market.
For many government and government-related entities, reducing borrowing has not been feasible as they must fund critical projects that align with national strategic plans, like Saudi Arabia’s gigaprojects and investments in hydrocarbons.
Data from the regional projects tracker, MEED Projects, highlights a robust project market in the GCC, with approximately $634.8 billion worth of contracts awarded by governments or government-related entities between 2019 and October 2024.
Saudi Arabia led the region with $360bn in spending, followed by the UAE with $124bn. Annual project spending post-pandemic in 2021-22 returned to pre-Covid levels, indicating minimal correlation between rising interest rates and capital expenditure.
Instead, oil prices have proven to be the primary driver of project market performance, with high revenues bolstering government budgets and sustaining investments. This resilience was exemplified in 2023, when $236 billion worth of projects were initiated in the GCC—the highest in a single year, surpassing the previous record of $170bn set in 2014.
Public and private sector spending trends further underscore the region’s project landscape. Public sector spending steadily increased from 2021, peaking at $280.3bn in 2024, reflecting strong post-pandemic recovery supported by robust oil prices.
In contrast, private sector spending reached its highest point in 2014 at $154.7bn during an oil boom but fell sharply to $70bn in 2019 due to global economic uncertainties, followed by a gradual recovery.
Notable milestones include 2014 as a peak year for private investments, 2019 marking the lowest combined spending, 2023 achieving the highest combined spending of $408.4bn driven by government-led initiatives and 2024 as the public sector’s record-breaking year.
These trends emphasise the dominant role of government spending, largely insulated by oil revenues, while private sector investments recover at a slower, more volatile pace.
Other borrowing
With an increase in spending, project clients –including public sector or government-related entities – have turned to various methods for raising capital and managing their exposure to interest rate risk.
One such example is the use of hedging, where borrowers are able to use tools like interest rate swaps or caps to lock in a stable rate or limit how high their interest payments can go, regardless of the direction of interest rate movements.
Many also balance their debt obligations by having a mix of fixed-rate and floating-rate loans, thereby limiting the impact of rising interest rates while benefiting from lower rates when available.
Ultimately, by diversifying their debt and employing these methods, borrowers can shield themselves from unpredictable interest rate changes, ensuring their financial obligations remain manageable.
Debt capital markets
For larger firms with access to debt capital markets, the rising cost of borrowing has led companies and government entities to increasingly turn to alternative debt-raising methods. This trend is reflected in greater debt capital market (DCM) activity levels.
In 2021-24, the issuance of various financial instruments experienced significant growth. Sovereign debt issuances, for example, surged by 45%, while sustainability-linked bonds increased by 83% in 2023 alone.
Additionally, DCM plays a vital role in managing interest rate risks by offering borrowers the ability to lock in fixed interest rates, protecting them from future rate rises.
The region’s DCM has grown 7% YoY, reaching $940bn outstanding at the end of the first quarter of 2024. Saudi Arabia dominates these figures in terms of the number of issuances, accounting for 43%, followed by the UAE at 30%. Fitch Ratings also forecasts that the GCC’s DCM issuances will surpass $1tn by 2025.
The growth in DCM has been mirrored by an increase in sukuk issuances in the region, with global volumes projected at $200-210bn in 2024, up from just under $200bn in 2023, according to Moody’s.
This increase is driven by robust sovereign issuances, particularly in the GCC, where sukuk issuance grew 138% year-on-year in the first half of 2024, reaching $69.2bn. Saudi Arabia led with $17bn issued, accounting for 37% of regional issuances, primarily for refinancing and Vision 2030 projects.
The UAE and Qatar also saw significant growth, with sukuk volumes doubling in the UAE and increasing 258% in Qatar. Additionally, the rise of green and sustainable sukuk, including Saudi Arabia’s $6bn in ESG-linked instruments, highlights the region’s growing focus on sustainability.
Having successfully weathered the high interest, high inflation period, governments and companies now face and must adapt to a very different scenario. By mid-2024, as inflation rates in North America and Europe normalised around 2%, central banks, led by the Federal Reserve, began cutting rates to stimulate economic growth, with the US central bank reducing the federal funds rate for the first time in four years by 50 basis points (bp) to a range of 4.75%-5%, followed by a further 25bp cut in November.
For the GCC, where higher oil prices have insulated public-sector project spending from recent interest rate hikes, a prolonged period of lower rates could offer new financing opportunities, particularly for the private sector.
Government-led infrastructure projects may benefit from reduced debt-servicing costs, enhancing the feasibility of ambitious development plans. Additionally, the private sector could leverage lower rates to accelerate their growth plans in sectors such as real estate, technology, and renewable energy, further diversifying the region’s economic base.
Looking forward, the gradual alignment of GCC rates with global trends may lead to increased foreign investment, as capital costs decrease.
However, with oil prices remaining a crucial factor, the region’s project finance landscape is likely to continue its reliance on government-backed projects. The interplay between oil prices and evolving interest rates will remain pivotal in shaping the future of GCC capital markets, underscoring the need for diversified funding strategies as the region adapts to shifting global economic conditions.
