The Cost of Financing Enters a New Phase... Are Our Sectors Ready?

Since the 2008 global financial crisis, we have lived through years characterized by a low-cost funding environment. During this period, corporate decisions, investments, and asset valuations were built on a familiar reality: financing was readily available at low cost, and refinancing debt did not impose the same burden as it would in a higher interest rate environment.

In my previous article, I discussed the transition of government debt from the era of low interest rates to the budgets of the higher interest rate era. However, the issue does not stop at governments; the same shift may face corporations, banks, real estate, financial institutions, and investors.

Recent indicators, in my view, warrant taking this possibility seriously. Yields on long-term government bonds in major markets have remained at levels higher than those to which markets had grown accustomed during the era of deeply negative interest rates.

At the same time, Federal Reserve Chair Jerome Powell, in his recent speech at Jackson Hole, confirmed that inflation remains above the 2% target and that the Fed’s current priority must remain price stability. Furthermore, the latest Fed meeting revealed several voices favoring a rate hike, with three members already voting in favor.

These data points do not mean that a rate hike at the next meeting is a foregone conclusion, but they raise a more important question: What if high funding costs are not a temporary phase?

This brings us to the question that concerns us in Kuwait: Have our companies and economic, banking, real estate sectors, and financial institutions stress-tested their accounts against the possibility that funding costs will remain at elevated levels for years, not just months?

This is not a theoretical question. The International Monetary Fund, in a study on Kuwait, examined the impact of US monetary tightening and found that the transmission of US interest rate changes to lending and deposit rates in Kuwait is strong in the short term and approaches completion in the long term.

Moreover, the study itself found that the impact of US monetary tightening on non-oil growth is larger and more prolonged when oil prices are below the fiscal breakeven level. In other words, our economy’s capacity to absorb this transition is significantly affected by the level of oil prices.

Here, the calculations begin to change. A company accustomed to refinancing its debt at low cost will face different calculations upon maturity, and a project that was viable at a certain funding cost may lose its viability when the cost of capital rises.

The real estate sector is affected in turn, as higher funding costs increase borrowing costs and the required return on investment. This also impacts demand and valuations, particularly when rental yields do not keep pace with the rising cost of capital.

As for the banking sector, the picture is more complex. Rising interest rates may support bank margins and profitability on one hand, but on the other, they increase the cost of funding for customers, potentially affecting credit demand and borrowers’ ability to service their debts.

Financial institutions and investment portfolios also face a different equation. When yields on lower-risk instruments rise, the comparison with equities, real estate, and alternative investments changes, leading to a reassessment of asset valuations and portfolio allocations.

Therefore, the rise in government bond yields in major markets does not concern the bond market alone; it reflects on the cost of capital, project viability, and investment decisions across various sectors.

Thus, I do not believe the most important question today is whether the Fed will raise interest rates at its next meeting. The most important question is whether our companies, sectors, and investments have tested their ability to operate in an environment where high funding costs may persist for years.

The next phase may not be a continuation of what we are accustomed to, but rather a different test of the financing structure, the viability of investments, and the capacity of sectors to adapt.