Banks in the UAE pay 1.25 per cent on time deposits with a maturity of one year. While this may look measly, two things matter for consideration here.
First, interest rates are still positive in the UAE, unlike Europe where they turned negative. (Yes, some European banks demand interest from depositors.)
Second, while the interest received by UAE depositors is positive, this is technically termed as nominal rate. When adjusted for inflation, the real rate of interest gives a different picture.UAE inflation (CPI) is running at 1.8 per cent. After adjusting for inflation, the real rate of interest in the UAE is minus 0.5 per cent.
This matters because negative real rates are good news for borrowers and bad news for lenders. From individual customers’ point of view, as depositors they lose out. As borrowers (especially consumer loans), they benefit. For corporates, it presents a great opportunity to clean up the balance sheet, reduce leverage or refinance high- cost loans with low-cost loans.
The UAE’s real rates have been negative since 2009, apart from a brief period between August 2011 and August 2012 when they turned positive. However, what is noticeable is the sharp and continuous descent in the rates since then.
For rates to turn positive, either nominal interest rates should move up or inflation should move down, or a combination of both. Given the US dollar peg to the dirham, UAE interest rates will mirror that of the US Fed. The Fed has now started raising rates but is finding the going tough. While the expectation is that the rates will rise from here, analysts are confused about the speed.
Regarding UAE inflation, the possibility of reduced rates can be debated owing to commodity price softening, although a reduction in subsidies can be inflationary. Average inflation since 2009 has been reined in at 1.7 per cent. Hence the UAE should brace for negative real rates of interest for some time to come.
But why should negative real rates of interest be problematic?
There are three reasons.
Consequently, preference for long-term deposits among customers has fallen and deposits at banking institutions, at best, are skewed towards the short end of the curve, a maturity period of one year or less. Time deposits, which accounted for 52 per centof private deposits in 2007, now account for only 28 per cent.
As a result, funding profiles of the banks are increasingly short-term in nature, which could constrain their ability to fund projects that are long term in nature owing to duration mismatches. The problem is exacerbated as banks have been the primary suppliers of capital in the region because of a lack of bond markets.