Dubai
In a surprise move last week, the Saudi Arabian Monetary Authority (SAMA) increased the key interest rates.
The central bank increased its repo rate, at which it lends to commercial banks, to 2.25 percentage points and its reverse repo rate, at which commercial banks deposit money with the central bank, to 1.75 percentage points.
Analysts see this unusual move is aimed at preventing capital outflow resulting from interest rate differential. SAMA stated in its announcement regarding the rate increases that the adjustment is “consistent for monetary stability in the evolving domestic and international monetary conditions”.
“We see this move by SAMA as a further step towards removing the discount that Sibor [Saudi Interbank Offered Rate] is currently trading at relative to US Libor. We believe that this negative spread reflects the ample liquidity in the Saudi banking sector, especially with the weak credit demand in the private sector and the government raising international debt to help cover its fiscal deficit. Ahead of the move, 3M Sibor was about 14 bps below 3M Libor,” said Monica Malik, Chief Economist of Abu Dhabi Commercial Bank.
Analysts say continuation and/or widening of Sibor discount could result in capital outflows or a shift in deposits from the Saudi riyal to the dollar.
Normally, Saudi Arabia and the GCC countries that have pegged currencies follow the Fed lead in interest rate changes. This time SAMA raised the rates a week before next Wednesday’s US Federal Reserve meeting, pointing to clear policy departure.
Analysts believe the move to hike rates highlights a shift in SAMA’s key priorities towards reducing this negative spread. Indeed, on March 5, SAMA suspended its term repo facility for maturities of seven, 28 and 90 days.
“We believe that by moving ahead of the Fed, SAMA is highlighting its commitment to raising rates and now specifically the repo rate in tandem with the Fed. Raising the repo rate at this point also suggests that SAMA wants to maintain a greater interest rate differential of 50 bps between the repo rate and the Fed’s FFTR (upper bound). We now expect SAMA to raise its benchmark rates three times in 2018, inclusive of the 15 March move, with the repo rate finishing the year at 2.75 per cent,” said Malik.
Despite the unusual out of turn rate hike by SAMA last week analysts expect, the Saudi central bank is sensitive to the growth impact of higher interest rates. Analysts say SAMA will still try to contain the pace of interest hikes given the lacklustre economic backdrop in Saudi Arabia. The need for loose monetary conditions was a key factor behind SAMA keeping the repo rate steady so far. Going forward analysts believe that SAMA could also look to manage the Sibor rate through open market operations.
As part of the liquidity management measures, the government could also increase the pace of domestic borrowing to absorb some of the excess liquidity in the banking system. Clearly, higher interest rates will act as a further headwind to domestic demand. So far, economic indicators suggest that key drivers of domestic demand in Saudi Arabia remain weak and private sector credit growth continued to contract in January year on year.
