Monetary easing to mark GCC economies in 2010

Governments expected to maintain high spending to spur growth, says Samba study. Banks would reopen credit taps later in 2010 as domestic demand picks up and banks' financial position strengthens. (EB FILE)

Oil producing Gulf Co-operation Council (GCC) states are expected to maintain aggressive monetary easing measures through the year to spur banks into unlocking their massive resources and resume normal lending to support their volatile economies.

The six GCC countries, which control nearly 45 per cent of the world's recoverable oil deposits, are also likely to keep the peg between their currencies and the US dollar after a cooling of inflation from record levels in 2008, which is expected to remain relatively low during this year.

Monetary easing measures, including low interest rates and reduction of compulsory reserve requirements for banks with the central bank, will be supported by ongoing fiscal stimulus steps undertaken by most countries in the region to counter the financial crisis.

The GCC's monetary easing is in sharp contrast with monetary restrictions imposed by GCC nations at the height of the oil boom in 2007 and in the first half of 2008 to contain soaring inflation triggered by a weakening of the US dollar, high rents at home and a surge in imported food prices.

Low policy rates to continue

The increase in inflation sparked strong speculation that GCC countries would appreciate their currencies against the dollar, to which they have been pegged for nearly 30 years. Speculation largely subsided after a recovery in the dollar, a decline in inflation and repeated statements by GCC monetary authorities that they had no intention of depegging their currencies.

"We do not expect any change in the GCC's exchange rate pegs to the US dollar in the next couple of years (with Kuwait retaining its peg to a dollar-heavy basket of currencies). Despite continued progress towards the stated goal of forming a Gulf Monetary Union with Saudi Arabia, Kuwait, Qatar and Bahrain, announcements from GCC officials concede that this is still a long-term project," the Saudi American Bank Group (Samba) said in a study.

"Given the retention of the dollar peg, GCC monetary policy will continue to be driven by the actions of the US Federal Reserve. We thus anticipate a continuation of low policy rates this year. As in the US, we expect inflation to be muted in the GCC, and thus do not expect a return of the exchange rate pressures that emerged in 2007-2008 when GCC and US policy needs and business cycles were out of synch. Current forward markets continue to reflect confidence in the dollar peg and are not pricing in any significant revaluation pressure within the next 12 months," it added.

Under monetary easing measures, GCC members have slashed interest rates and lowered the reserve requirements to encourage banks to end their tight credit approach that was spawned by the global crisis and a severe debt default problem involving two major family businesses from Saudi Arabia.

Despite such measures, lending has remained tight but analysts expect banks to gradually reopen their credit taps later this year as domestic demand picks up and the banks' financial position strengthens as a result of heavy provisions.

"Interest rates in Saudi Arabia are expected to remain very low. The exchange rate peg to the US dollar means that the kingdom's interest rate policy is guided by that in the US, though there is some room for manoeuvre," Riyadh-based Jadwa Investments said.

Forecasts for dollar stability

"The [Saudi] riyal will remain pegged to the dollar. There is a broad consensus that the dollar will be on a downward trend over the medium-term owing to the vast number of new dollars generated by the US stimulus programme, the unwinding of global imbalances and the gradual diversification of central bank reserve holdings. However, we think that the dollar will be relatively stable during 2010," it added.

According to Jadwa, monetary easing in the GCC would be backed by high public spending through 2010 on the grounds that strong crude prices would enable regional governments to keep expenditure high and offset lower private investment. It noted that high public spending was the main driving force in preventing a contraction in most GCC economies in 2009.

"Government spending will provide the main stimulus to the economy in 2010. Despite the increase, we forecast a budget surplus of around SR15 billion (Dh14.68bn) in Saudi Arabia although it has assumed a deficit," it said. "This is because we expect the oil price to be higher than that used [as a basis for budgetary estimates] and therefore that oil revenues will exceed the budgeted total."

Samba also expects GCC governments to maintain high spending in 2010, buoyed by improved oil prices, which are projected to average around $70 (Dh257) a barrel compared with nearly $60 a barrel in 2009. "The strength of GCC public finances will return as a major theme this year as oil prices hold on to recent gains, raising fiscal and current account surpluses and adding to the region's large pool of external savings," it said.

It noted that although Saudi Arabia accounts for about half of GCC fiscal spending in any given year, the region as a whole is still projected to post a fiscal surplus of nearly five per cent of the gross domestic product (GDP) and a current account surplus of over 10 per cent of GDP this year. "In 2010, GCC governments plan to maintain the expansionary fiscal policy of recent years, which has served as the main driver of growth in the region. We expect government spending will rise by around 14 per cent this year to a record $354 billion, bolstered by stronger oil prices," Samba said.

Spending to exceed budgetary quotas

It pointed out that a large proportion of this spending has been earmarked for infrastructure investments to support growth in regional economies. "As is customary, spending levels are expected to exceed the amounts presented in official budgets. However, given that most governments have based their budget revenues on oil price assumptions of well below our $75 per barrel projection for 2010, we should still see solid improvements in fiscal balances," the study added.

While inflation could edge up in some member states this year as a result of heavy spending, stronger domestic demand and relatively high rents, it will remain far lower than the 2008 rates, according to the Banque Saudi Fransi (BSF). "After soaring to a record 9.9 per cent in 2008, inflationary pressures subsided in 2009 due to slower domestic demand, lower global commodity prices, a retreat in food prices and a decline in domestic rents. The circumstances led to deflationary trends in some GCC countries, particularly Qatar, although we do not foresee a substantial decline in inflation this year," it said.

"In Saudi Arabia, we expect annual inflation to average 4.3 per cent this year, compared with 5.1 per cent in 2009. Greater economic activity, domestic demand, higher rental costs, higher food prices and an imported inflation component should place upward pressure on inflation. Additional market liquidity (broad money supply) could also add to price pressures but could eventuate toward the second half of the year," it said.

Inflation in the GCC, which began in May 1981, peaked at around 11.1 per cent in 2008 before diving to nearly 2.9 per cent in 2009.

Independent estimates showed the rate could climb slightly to around 3.5 per cent this year but will be unlikely to return to the 2007-2008 levels despite monetary easing measures and high public expenditure. One of the main reasons is that banks are not expected to return to the pre-crisis lending saga although a recovery in GCC economies because of higher oil prices, will spur domestic demand.

"Having fallen steeply from 11.1 per cent in 2009 to 2.5 per cent in 2009, the rate of inflation in the GCC is expected to pick up again this year. However, the increase is likely to be mild – at 3.5 per cent – and we do not expect to see a return to the exceptional rates of 2007-2008," Jadwa said.

"While GCC economies are projected to recover, aggregate demand growth will be modest and credit growth will be comparatively restrained despite the accommodative monetary policy stance. External influences will ease as the year progresses and we do not see new sources of imported inflation during the year. Inflation in trading partners is a key determinant of inflation in the kingdom and given the significant spare capacity within the global economy, this will be low," it added. In the UAE, inflation tumbled to as low as 1.5 per cent in 2009 after climbing to a record high of 12.3 per cent in 2008, according to official data.

In Saudi Arabia, inflation fell to an average of 4.4 per cent in 2009 from 9.9 per cent in 2008. Projections by Samba showed Qatar recording average annual deflation of four per cent in 2009 mainly as a result of a sharp decline in rents. It said the fall reflects the downturn underway in the real estate sector which is likely to linger this year, dampening overall inflation prospects. "However, significant inflationary pressures could arise from surging external inflows, higher public spending, increased commodity prices and a weak dollar. We project inflation will rise to six per cent by 2011."


The UN Economic and Social Commission for Western Asia (ESCWA), which groups the Gulf Co-operation Council and other Arab nations, says that levels of inflation in 2009 were far lower than those recorded in 2008, when some GCC states saw double-digit inflation rates.

For 2010, the commission projected inflation of 4.1 per cent in Qatar, 4.2 per cent in the UAE, four per cent in Saudi Arabia, 4.7 per cent in Kuwait, 3.2 per cent in Oman and 4.7 per cent in Bahrain.

"In Saudi Arabia, a further decline in the price level is forecast for 2010 with a consumer inflation rate of four per cent as the economy is returning to its historical trend. In the UAE, the economic recovery is forecast to lead consumer inflation to 4.2 per cent in 2010," the ESCWA said.

"In Kuwait, the inflation rate in 2010 is forecast at 4.7 per cent based on the recovery of the domestic economy while the recovery in domestic demand in Qatar is expected to raise the inflation rate to 4.1 per cent in 2010.

In Bahrain, the stable trend is forecast to continue into 2010 with a 3.6 per cent consumer inflation rate and in Oman, the declining trend is forecast to continue this year with a 3.2 per cent inflation rate," it added.


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