Saudi to keep rates unchanged in 2010-2011

Saudi Arabia is expected to keep interest rates unchanged this year and in 2011 as it continues to match the monetary policy of the United States which will unlikely change rates, the Gulf Kingdom’s largest bank has said.

The rates in the world’s oil superpower could remained unchanged even if banks unleashed their swelling liquidity and decided to end lending curbs they introduced in the aftermath of the global fiscal distress, National Commercial Bank (NCB) said in a study sent to Emirates 24/7

NCB, the largest Saudi bank by assets, said it believed the expectation of an interest rate hike in the US looks slim, adding that this means a unilateral move in rates by the Saudi Arabian Monetary Agency (SAMA) is unlikely.

It said two factors would affect the US policy rates, including a growing consensus that US GDP will slow significantly in the second half of 2010, with the unemployment and housing markets still ailing.

The second factor is that “deflation” is becoming a worry especially that prices had trended down over the past two years.

“Accordingly, it can be easily ascertained that the accommodative monetary policy adopted by SAMA would be maintained, with the repo and reverse repo rates kept at two and 0.25 per cent, respectively.…even though we expect money supply growth to pick up next year due to new money injection from the moderate growth in credit activities, yet it will be a mild The outlook for monetary policy reveals no expected change in interest rate this year and next.”

 “The main risk to our outlook stems from SAMA’s need to tighten its monetary policy ahead of the US if there is a sudden surge in lending activities and a further improvement in oil prices.”

But the study said it believed that despite the plausibility of this scenario, changing the benchmark interest rates will not be an option since SAMA is expected to resort to other tools at hand.

They include increasing the statutory reserve requirement on deposits, and expanding the issuance for treasury bills further, which is an effective tool in short-term liquidity withdrawal that can fall short if banks opted for higher-yield credit facilities. “Bottom-line, SAMA is likely to preserve the repo and reverse repo rates in 2010 and 2011, maintaining the repo/ reverse repo spread.”

 NCB said the current monetary policy adopted by SAMA, the country’s central bank, has become more manageable than in the heydays of the global crisis.

It noted that ample liquidity and subdued interbank rates had enabled SAMA to cease the “myriad unconventional monetary tools” put in place since 2008.

“First, in terms of hard-currency funding, SAMA had ceased its foreign currency swaps that were used to inject the much needed liquidity into local banks.

Interestingly, by the end of 2009 and 1Q 2010 no FX swaps were conducted compared to the significant USD13.6 billion undertaken for the whole of 2008.”

The study said SAMA had also withdrawn almost all of its emergency deposits with the local banking system as well as those that were injected by independent organizations, notably the General Organization for Social Insurance and the Public Pensions Agency by the end of 2009.

Recently, the deposits of the independent organizations with local banks had plunged till it was recorded at zero in May 2010, compared to the historical high of SR15.97 billion registered in 2008, the report showed.

In addition, open market operations have relatively eased, falling by around SR55.7 billion, driven lower by the reduced volume of treasury bills.

“Obviously, the liquidity and interbank specters had weighed on SAMA’s decisions, given lower local currency borrowing costs, with the average 3-month Saudi interbank rate (Saibor) hovering around 49-52 bps above the benchmark reverse repo rate in 2009 and 2010 year to date,” it said.

“In our opinion, the medium-term outlook for SAMA’s monetary policy would resemble the current dynamics, especially that the ball is in the territory of local banks, many of whom had decided to remain conservative.”

But the report noted that SAMA is becoming more aware that such improved liquidity could be a “double-edged sword” that stokes inflationary pressures.

Citing government data, it said inflation in the Kingdom had been on an upward trajectory since October 2009, edging higher to 5.5 per cent by the end of June 2010 on the back of the food and rent components.

It said two other factors could push inflation higher. The first is that excess reserves could pose a potential threat if banks opt to aggressively utilize these funds. “The fire power is there especially that the excess reserve ratio had ended last year at 66.3 per cent, amounting to around SR98.9 billion, a turnaround from the historical low of 4.4 per cent recorded in October 2008.”

The second factor, the report added, is that a sizable portion of the government securities will mature by the end of this year, mainly Saudi Government Development Bonds (SGDBs) that were issued in 2005, 2006 and 2007.

“As such, SAMA has decided to proactively deal with the issue on two fronts.

First, it has expanded the Treasury bills issuance limit from SRthree billion to SR nine billion per week in the first quarter of 2010 in anticipation of the need to replace the matured issuances with treasury bills,” it said.

“Second, on the execution front, it has increased the issuances of treasury bills by a staggering SR27.4 billion since last December. We do believe that these early moves would prove sufficient to contain any inflationary pressures in the medium-term, if they do arise….nevertheless, we expect the upside potential for an inflationary spiral in 2010 and 2011 to be highly unlikely, with money supply growth hitting the nadir. After the moderate growth in 2009 at 10.7 per cent, money supply growth (M3) decelerated sharply to 3.4 per cent Y/Y in June.”

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