Three Gulf states cut rates to defend dollar peg

Filed on March 19, 2008

DUBAI - Three Gulf Arab oil producers lowered some interest rates on Wednesday to defend their dollar-pegged currencies after a US rate cut despite the risk of stoking already near-record inflation.

Saudi Arabia and Bahrain, the largest and smallest economies in the world’s biggest oil-exporting region, cut deposit rates by 75 basis points to 2.25 percent , matching a reduction by the Federal Reserve.

They left lending rates steady as they try not to fuel money supply growth, while the United Arab Emirates, the second-largest Arab economy, cut its repurchase rate -- the rate at which banks borrow from the central bank -- to 2.25 percent.

“For the time being, they want to maintain their pegs,” said Hany Genena, director of economic research at Gulf Finance House in Bahrain. “But in doing this, the sacrifice is lower interest rates, which may end up stoking inflation,” he said.

Qatar had yet to decide on its response to the Fed on Wednesday, a central bank official said, and Kuwait -- which severed its dollar peg last year -- kept all rates unchanged as the US currency trades near record lows against the euro.

Kuwait has allowed its dinar to rise more than 8.5 percent since severing its dollar link last May, giving it more flexibility to address imported inflation.

For the other five Gulf states, tracking the sixth Federal Reserve rate cut since Sept. 18 will only spur Gulf economic growth and inflation at a more than quarter-century peak of 7 percent in Saudi Arabia and a near-record 13.7 percent in Qatar.

Saudi Arabia, which has kept its riyal at the same rate against the dollar for 22 years, left its benchmark repurchase rate unchanged at 5.5 percent.

As in the UAE, however, the interbank markets are awash with liquidity and banks have little reason to borrow from the central bank.

Lower one-month interbank rates -- at 2.26 percent in Saudi Arabia and 2.22 percent in the UAE on Wednesday -- are likely to feed into lower borrowing costs for companies and individuals, analysts said.

“Effectively, by cutting policy deposit rates, central banks are inducing a cut in the retail deposit rate and hence retail lending rates,” Genena said.

Reform calls

At a time when the United States is lowering interest rates to revive its economy, Gulf economies are surging on a five-fold increase in oil prices since 2002.

Rate cuts will help spur economies further, helping to create jobs in Saudi Arabia, where unemployment is at 15 percent, said John Sfakianakis, chief economist at HSBC Holding Plc’s Saudi affiliate, SABB.

The world’s largest oil exporter has slashed its reverse repurchase rate by 3 percentage points in the last six months to 2.25 percent.

“You are likely to have higher growth and higher inflation,” Sfakianakis said. “It’s a price worth paying in a country where 300,000 people are coming onto the job market each year,” he said.

Still, calls for currency reform are growing in the Gulf, where forward rates show investors betting on 3.3 percent and 4.2 percent appreciation in the UAE dirham AEDF and Qatar riyal QARF in a year.

Qatar’s prime minister told Reuters last month the riyal was 30 percent undervalued and the Gulf state was considering revaluing its currency to combat inflation.

The Qatar Central Bank would decide on a response to the Fed cut on Thursday, said an official who declined to be identified.

HSBC Holdings said in a report this month that there was a 40 percent chance Gulf states could change foreign exchange policies this year as they face a “perfect storm” of “dollar weakness, falling US rates, high oil earnings and rising inflation”.

Bahrain lowered its benchmark one-week deposit rate by 75 basis points to 2.25 percent, while leaving its lending rates unchanged at 5.25 percent.

Oman sets interest rates at a weekly auction of certificates of deposit on Mondays. Its repo rate was 3.77 percent on Wednesday.

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