Saudi may slightly raise rates

Saudi Arabia could keep interest rates unchanged this year despite sluggish lending but a slight hike of 25 percentage points to match any US rate increase could not be ruled out, the Gulf kingdom’s largest bank has said.

National Commercial Bank (NCB) also urged the Saudi Arabian Monetary Agency (Sama), the country’s central bank, to keep an eye on inflation following a pick up in monetary aggregates and domestic credit.

“The outlook for monetary policy reveals no increase in interest rate this year as well, yet a symbolic 25 basis points cannot be ruled out,” it said in a study. “Given the lock-step nature of Saudi monetary policy with the US, the Federal Reserve interest rate decisions influence domestic benchmarks.”

The report noted that US unemploym ent continues to be an important factor in the Fed’s decisions, and even though joblessness fell for the fourth consecutive month, with the rate of unemployment declining to a two-year low of 8.8 per cent in March, the sustainability of the jobs situation is still uncertain.

Additionally, core inflation, which stood at just 0.10 per cent year-on-year in March, is in Fed’s opinion below levels judged to be consistent with price stability and maximum unemployment, the report said.

These factors do support the Fed’s wait-and-see approach that wants to ensure the existence of a positive trend and not just a blip in economic activities.

“Accordingly, it continues to adopt $600 billion Large Scale Asset Purchasing program in order to further stimulate the economy and maintain growth. Notwithstanding its stance, the Fed may opt for a symbolic 25 basis points increase to follow the ECB (European Central Bank) that raised the main refinancing rate for the first time since mid-2008 to 1.25 per cent and is expected to steadily raise it to 1.75 per cent by the end of 2011,” NCB said.

“The triggers for this scenario would be to show adamancy to anchor inflationary expectations, and to avoid widening interest differentials against EUR that can be detrimental to demand on US treasuries, and as such to financing the budget gap and rolling-over existing debt….Bottom-line, despite the plausibility of this scenario, the Fed is not expected to raise its target funds rate until the first quarter of 2012, and as such SAMA will maintain the repo and reverse repo rates at two per cent and 0.25 per cent, respectively.” But the report warned that SAMA should better watch inflation after its figures showed there was a pick up in monetary aggregates and domestic credit following a sharp slowdown caused by the 2008 global fiscal distress and debt defaults by two key Saudi family businesses.

“Sama will have to become more vigilant on the inflation front during the medium-term. Obviously, all quiet on the liquidity and interbank fronts, given the lower local currency borrowing costs, with the average 3-month Saudi interbank rate (Saibor) registering 74 and 75 basis points in 2010 and so far this year.”

But it noted that monetary aggregates that recorded sluggish growth rates in 2010, with the monetary base and the money supply registering annual growth rates of 2.5 and five per cent compared to 37.9 and 10.7 per cent, respectively in 2009, has started to gain momentum earlier this year. “Most importantly, a substantial shift from excess deposits with Sama towards credit facilities has ensued, as excess deposits fell to SR72.1 billion by the end of February, which is a staggering plunge by SR17.2bn from last year’s closing figures,” NCB said.

“This has coincided with the recent pickup in project finance activity and contracts awarded. In fact, all the project finance deals and nearly 70 per cent of the awarded construction contracts were concluded in the second half of 2010.”

According to the study, private credit grew by 6.5 per cent , the fastest pace since June 2009, thus, largely driving the growth in broad money to 13.8 per cent so far this year, which is the highest since July 2009, as demand deposits continued to report double-digit growth rates.
“We do anticipate higher multiplier effects inside the economy that can elevate monetary aggregate and un-anchor inflationary expectations. SAMA is clearly aware that monetary policy has a transmission mechanism that needs time to achieve an acceptable price level, and that any action taken on the interest rate dimension could take at least 3-6 months to affect monetary variables,” it said.

“But given the dollar peg, SAMA might opt for other tools if the US economic realities remained divergent from the kingdom’s.”

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