Saudi money supply hints at deflation in the Kingdom

Saudi Arabia's money supply maintained downward trend for the second week running this month as the world's oil superpower appeared to be heading for deflation because of the international economic distress.

Official figures showed the Gulf Kingdom's inflation rate dived in March to its lowest level of six per cent in nearly a year despite measures by the country's central bank to cut rates to spur lending and offset the impact crisis.

The figures by the Saudi Arabian Monetary Authority (Sama), central bank, showed liquidity declined last week to its level nearly a month ago after recording a steady and rapid increase in the previous months.

M1, including currency outside banks and demand deposits, slumped by 1.05 per cent during the second week of May over the previous week, the figures showed. M2, which involves M1 plus time and savings deposits, slipped by 0.71 per cent while M3, covering M1, M2 and quasi money, fell by 0.85 per cent.

At the end of last week, M3 stood at SR981.5 billion, (Dh969.5bn) down from SR989.9bn in the previous week and as high as SR1.001.3bn in the last week of April.

The decline in money supply in the Kingdom coincided with a steady fall in inflation rates after hitting record levels in 2008 because of strong oil prices, weakening in the US dollar and a surge in global commodity prices.

According to Sama, inflation in March stood at six per cent compared with 6.9 per cent in February and 7.9 per cent in January.

It climbed to a record annual level of 9.9 per cent in 2008, more than double the 2007 rate of 4.1 per cent.

"2009 is now accepted as a marked pause of the economic boom Saudi Arabia experienced since oil prices began to rally in 2003," said NCB Capital, an offshoot of the Saudi National Commercial Bank.

It referred to forecasts by the International Monetary Fund that the Kingdom's economy would contract by around 0.9 per cent in real terms this year in sharp reversal of the 4.2 per cent growth recorded in 2008.

"In spite of numerous policy steps taken by Saudi government and Sama to limit the local impact of the global downturn, falling oil prices and tighter liquidity have hit business confidence and domestic consumption," NCB Capital said.

Its figures showed private consumption as measured by point of sale transactions fell to 13.5 per cent in February from a growth of around 34 per cent in the corresponding period a year earlier.

In addition, the growth of credit to the private sector dipped to a rate of 20.9 per cent in February, down from 23.9 per cent in January and 27.9 per cent in December 2008. At the same time, credit to the public sector declined by 13.4 per cent in February, following a 25.2 per cent drop in January.

In a bid to encourage bank lending and spur private investment, Sama cut the reverse repo rate by 25 basis points to 0.5 per cent on 15 April 2009 as part of an overall monetary policy aimed at mitigating the fallout of the global crisis.

"The Kingdom is now expected to go through a brief period of deflation in 2009 as the economy slows down… this could prompt Sama to cut the policy rates and bank reserve requirements again in order to boost credit in the economy."

According to NCB Capital, although monetary easing by Sama has eased liquidity constraints in the Saudi financial system, it has so far had a limited impact on credit growth as most banks are becoming more careful.

"Stagnant equity markets, underdeveloped debt capital markets and reduced FDI due to risk aversion by international investors have placed most of the burden of financing economic activity on the country's banking sector," it said.

"Despite its general health, the Saudi banking sector has only limited capacity to expand credit. The primary area of concern is the Saudi banks' reliance on non-deposit funding – foreign financing, interbank borrowing, and repos. Saudi Arabia's banks have a comfortable loan-to-total deposit ratio of 71.1 per cent in the first quarter of 2009, well below Sama's limit of 85 per cent."

The report expected customer deposits to show limited growth in 2009 which may reduce banks' willingness to lend.

"The tighter financial markets have limited Saudi banks' ability to raise non-deposit funding. Non-deposit funding of banks has declined 26.3 per cent since the 2008 Q3. The relatively short-term nature of banks' deposit base constitutes another limiting factor which can in principle be overcome to a degree by government initiatives such as infusions of long term deposits."

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