Saudi Arabia likely to maintain interest rates this year: Jadwa

Saudi Arabia is expected to keep interest rates unchanged for the rest of 2009 after a spate of cuts failed to spur banks to resume normal lending activity to stimulate the crisis-hit economy, said a Saudi investment firm.

Despite such cuts over the past few months and other monetary easing measures, Saudi banks have remained as tight as they were just after the eruption of the global financial distress, said Jadwa Investments.

Lending activity by the kingdom's 12 commercial banks has faltered not due to liquidity shortages but because they have adopted a risk-aversion credit policy following the global crisis and the recent debt default problem, said Jadwa.

While monetary easing by the Saudi Arabian Monetary Agency (Sama), the central bank, has failed to spur bank lending, it has pushed down inter-bank rates to one of their lowest levels.

"Sama has continued to implement an appropriately loose monetary policy. Interest rates have been cut further this year and are expected to remain at their current exceptionally low levels for the remainder of the year. While lower interest rates and other policy measures have brought down interbank rates, they have yet to stimulate a sustained revival in commercial bank lending," said Jadwa.

"We do not expect a change in interest rates over the remainder of the year. The US Fed funds rate is likely to remain at its current level over this period and we do not anticipate Sama taking further independent moves. We think that Sama has done what it can to make the environment conducive to lending and that it is risk aversion rather than lack of liquidity that is discouraging banks from lending."

So far this year, Sama has cut interest rate cuts three times as part of measures to push banks to break out of their tightness, which is seen as one of the key factors that are stifling growth in the largest Arab economy.

In mid-January, Sama lowered the repo rate, the rate it charges for lending to commercial banks, to two per cent from 2.5 per cent and the reverse repo rate, the rate it pays for deposits, from 1.5 per cent to 0.75 per cent. The reverse repo rate was then cut to 0.5 per cent in mid-April and to 0.25 per cent in mid-June, while the repo rate has been left unchanged.

Given the exchange rate peg to the US dollar and the absence of capital controls, it is usual for rates in Saudi Arabia to broadly shadow those in the US, but all of the reductions so far this year were done independently of US rates. This is partly because there is effectively no scope for US rates to go any lower as the Fed funds rate has been at 0-0.25 per cent since December.

Sama has also judged that the series of rate cuts in the final quarter of last year have has not been sufficient to effectively stimulate the economy. The reductions to the reverse repo rate appear designed to encourage a resumption of commercial bank lending, which would be a key sign that economic conditions were improving.

Bank caution caused deposits at Sama in excess of the statutory requirement to surge from SR0.9 billion (Dh0.88bn) in October to a peak of SR88.9bn in April. They fell back to about SR79bn in July, but this was not reflected in higher lending. Reducing the reserve repo lowers the return on these deposits and potentially encourages banks to lend, rather than hoard, funds.

Other policy steps taken during the year, such as reducing the issuance of treasury bills and holding the price at which the bills were issued below the interbank deposit rate, have also been designed to free funds for banks to lend.

"While the supportive monetary policy has not yet contributed to a recovery in bank lending, it has helped push interbank rates to all-time lows," said Jadwa. "The three-month Saudi interbank offer rate (Saibor) stands at 0.65 per cent, down from 2.51 per cent at the end of last year. Lending and particularly deposit rates have also fallen notably. An additional reason for the last cut in the reverse repo was that it was above short-term deposit rates, meaning that Sama was paying out more to the banks than it needed to."

In a recent study, the Saudi American Bank Group (Samba) said banks were pushing ahead with a drive to rebuild their foreign assets at the expense of local lending activity despite Sama's monetary easing moves.

"The banks are continuing to build foreign assets as domestic lending stagnates. Sama's cut to its reverse repo rate has not stimulated commercial bank lending to the private sector," it said.

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