Business | Economy
Gulf suffers its own liquidity squeeze
Cost of short-term funding in local money markets soars far above benchmark interest rates.
- By Robin Wigglesworth, Financial Times
- Published: 23:12 September 5, 2008
When the subprime mortgage market bubble burst to devastating effect for financial markets, many argued that the Gulf would be protected from the credit crunch by robust economic growth and a profusion of petrodollars coming into the region.
Until recently this belief held true, apart from a smattering of subprime-related writedowns.
But this summer the cost of short-term funding in the local money markets has soared far above the benchmark interest rates in the Gulf and led to what some have termed the region's very own "liquidity squeeze".
Local money market rates were subdued until recently, in part because international banks have been betting that some countries would revalue their currencies against the dollar. These bets held down the difference between the benchmark rate and the effective money market rate - the spread.
Ample access to funding bred complacency when it came to increasing deposits at banks, according to economists. As revaluation speculation has waned, banks have had to scramble around for funding elsewhere to fill the gap between deposit and credit growth.
With international money markets clogged up, local banks have turned to the local interbank markets, and that has raised costs.
Last week the three-month Saudi interbank rate was at 4.22 per cent and the UAE rate stood at 3.12 per cent compared with a benchmark rate of 2 per cent.
In Kuwait the rate was 4.18 per cent compared with a 3.5 per cent repo rate. Many experts in the region welcome this trend. Ala'a Al Yousuf, chief economist at Gulf Finance House, says the Gulf "needs higher rates to slow growth and bring down inflation to something a bit more measured".
Maintaining the dollar peg stymies independent monetary policy, and governments are unwilling to limit fiscal spending. So central banks have been casting around for other ways to contain inflation. Many have increased banks' reserve requirements to limit lending.
To mop up extra liquidity the Saudi Arabian Monetary Agency issued 73.9 billion Saudi riyal ($19.7 billion) in the first seven months of the year - a more than threefold increase of the total issuance last year.
"The government is clearly more aware that a small portion of debt is an acceptable cost in managing monetary policy," wrote National Commercial Bank, a Saudi lender, in a recent research note.
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