Fiscal steps will 'stifle growth and not curb inflation'

Inflation in Saudi Arabia is expected to reach 8.2 per cent this year. (AFP)

A series of fiscal measures by Saudi Arabia's monetary authorities have stifled growth in money supply after several months of rapid increase but would not curb inflation, according to analysts.

The decisions by the Saudi Arabian Monetary Agency (Sama) to force all banks operating in the Kingdom to increase their reserves with Sama could also smother growth in their profits.

"New data shows that two earlier increases in the reserve requirement for current accounts had little effect… money supply growth fell to a three-month low of 23 per cent in March but private sector credit continued to rise and bank lending to the private sector as a proportion of deposits was higher than before the reserve requirement was increased," the Riyadh-based Jadwa investment company said.

"The sharper tightening of reserve requirements has come against a backdrop of slowing interest rate cuts… nonetheless, interest rates will stay very low [well below zero in inflation-adjusted terms]. We, therefore, think that the higher reserve requirements should restrain the growth in money supply but are unlikely to slow it significantly. We believe the combined effect of two recent raises should restrain money supply growth though not by enough to have material impact on inflation," Jadwa said.

Sama, Saudi Arabia's central bank, has raised the reserve requirements for current accounts four times since November to 13 per cent and for the first time lifted the reserve requirements for time and savings deposits to four per cent from two per cent. The moves, aimed at stemming swelling domestic liquidity and reversing acceleration in inflation, require banks to lift their statutory reserves with Sama. The latest two moves meant those reserves should be increased by around SAR16 billion (Dh15.7bn). Since November, the banks have been required to set aside an additional SAR25.1bn as reserves, equivalent to 2.1 per cent of total assets.

"Higher reserve requirements will eat into bank profits even if they do not impact materially on lending growth," said Brad Bourland, chief economist at Jadwa. "This is because statutory reserves at Sama do not earn interest, whereas other deposits receive interest based on the reserve repo rate… banks will therefore need to increase the spread between lending and deposit rates in order to maintain profitability – raising the former would also help contain money supply."

Like other Gulf oil producers, Saudi Arabia is reeling under soaring inflation rates because of an upsurge in the economy, strong domestic demand, the nominal decline in its currency because it is pegged to the weak US dollar, and a sharp rise in rents and food prices.

Another key factor appears to be a surge in public spending above the budgeted expenditure due to a large increase in the Kingdom's petrodollar income.

From zero to two per cent in most years over the past two decades, inflation in Saudi Arabia soared to 4.1 per cent last year and is expected to double in 2008.

"Rents and food prices remain the main sources of inflation, but the price rises are now spreading. In year-on-year terms inflation picked up in each of the eight subcomponents of the cost of living index in February," Bourland said.

"This spread of inflation will complicate policy to contain it and further fuel the public's inflation expectations. We have again revised up our forecast for inflation for this year; we now expect it at 8.2 per cent."