Emirates NBD sees UAE rate climb reversing on tax giveaway

The government probably held as much as $11bn in bank deposits following the introduction of a 5% value-added tax in early 2018
Emirates NBD sees UAE rate climb reversing on tax giveaway
The outlook for interest rates in the US is another factor that should push borrowing costs lower in the UAE, according to Emirates NBD.
By Bloomberg
Wed 17 Apr 2019 03:00 PM

An “unsustainable” increase in the United Arab Emirates’ lending benchmark will reverse once the government doles out the tax revenue whose withdrawal from deposits spurred the rise, according to the biggest bank in Dubai.

The three-month Eibor has climbed in the past three weeks despite a decline in a similar dollar rate, an oddity because the dirham is pegged to the US currency. The spread with the three-month Libor widened to 36 basis points last week, the biggest differential in more than two years, according to data compiled by Bloomberg.

The federal government’s “sudden withdrawal of cash from the large Eibor-fixing banks” is probably to blame, Anita Yadav, the head of fixed-income research at Emirates NBD, said in a report. As banks came under funding pressure, they responded by paying high interbank rates to lure money ahead of quarter-end reporting, she said.

The government probably held as much as 40 billion dirhams ($11 billion) in bank deposits following the introduction of a 5 percent value-added tax in early 2018, and cash built up because the distribution of the proceeds to individual emirates had yet to be finalised, Yadav said.

Eibor’s rise and its widening spread with Libor came after the federal government “is believed to have withdrawn these deposits” and placed them with the Ministry of Finance, according to Emirates NBD.

“This phenomenon is likely to reverse once the money is distributed,” Yadav said. The widening Eibor-Libor “spread is unsustainable and likely to mean-revert to lower levels within this quarter.”

The outlook for interest rates in the US is another factor that should push borrowing costs lower in the UAE, according to Yadav. Federal Reserve officials in March forecast no rate increase this year and just one in 2020, according to their median estimate. That marked a pivot from their December forecast that signalled two hikes in 2019.

Investors have recently boosted bets on the next Fed move being a cut, according to pricing in interest rate futures contracts.

“In such an environment, given the dirham’s peg to the dollar, interbank rates in the UAE theoretically should also have come down or remain range bound with respect to the recent decline in Libor rates,” Yadav said.

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