By Andrew Torchia / Reuters
DUBAI: Saudi Arabia’s market interest rates are climbing as the economy booms, but the rise is as much due to international pressures as strain on banks’ lending resources, and any hike of official rates probably remains distant.
The increase in interbank lending costs underlines how Saudi money markets are returning to normal since a sudden increase in government spending last year, announced in response to the Arab Spring uprisings in the region, flooded the banking system with money and pushed rates down to record lows.
The three-month Saudi Arabian Interbank Offered Rate has risen to 0.88 percent, its highest level since May 2009, from last September’s low of 0.60 percent. Longer-term interbank rates up to one year have increased by slightly smaller margins, while Treasury bill yields are up in sympathy.
The trend coincides with the country’s fastest economic growth in a decade, thanks to high oil prices and heavy government spending on infrastructure and social programs. Economy and Planning Minister Mohammed Al-Jasser said this week that gross domestic product was heading for 6 percent growth this year after 6.8 percent in 2011.
But other data suggests the economy is still far from the late stage of an economic cycle in which higher demand for funds puts heavy pressure on supply, pushing up market rates.
Commercial banks’ excess deposits at the Saudi Arabian Monetary Agency (SAMA) stayed high at 88.5 billion riyals ($23.6 billion) in February, data released by SAMA at the weekend showed. That was down from 95.4 billion riyals in January but well above levels of around 50-60 billion that prevailed in most of the second half of 2011.
Meanwhile, the ratio of banks’ private sector loans to their deposits was 78.5 percent in February, barely changed from January and below levels around 80 percent seen in the second half of last year. That leaves plenty of room for banks to expand lending further if needed.
Excess funds in the banking system are still high and haven’t decreased to the point where their level would boost domestic market rates, said Paul Gamble, head of research at Jadwa Investment in Riyadh. “The pressures for higher rates are external.”
One pressure is higher short-term US dollar rates, which have risen from their mid-2011 lows, partly because of signs of greater strength in the US economy. Saudi Arabia pegs the riyal to the dollar so arbitrage between the two currencies tends to limit how much rates can diverge.
“The level of interest rates has been rising with the level in the US because of the exchange rate peg – rates have been following US dollar Libor, with a bit of a lag,” Gamble said.
But US rates are not the full story; since the start of this year they have stopped rising even as Saudi rates have continued climbing. One-year SAIBOR is now 4 basis points above the one-year dollar London Interbank Offered Rate, after being 9 bps below it at the start of 2012.
So many analysts think the rise in Saudi rates is also due in part to banks demanding higher rates because of risks they see in the global economy, such as the euro zone debt crisis, or geopolitical dangers in the region.
The biggest geopolitical threat is the controversy over Iran’s nuclear program. As this year’s 24 percent jump of Saudi Arabia’s stock index shows, investors do not think military conflict in the Gulf is likely, but banks may be hoarding funds just in case.
“We think the rise (in rates) reflects local banks’ anxiety about a possible global slowdown and regional geopolitical risks rather than a fundamental tightness in local banking liquidity,” Barclays analyst Fahad Al Turki wrote in a report.
Added a fund manager at a Saudi financial firm, “Some banks may be building up some liquidity capacity to cover some positions in Europe in case of an adverse event, which may also be having an effect on market rates.”
Global risks only go a limited way towards explaining the rise in Saudi rates, however; five-year Saudi credit default swaps, which investors use to hedge against threats to the economy, have dropped since the start of 2012.
So higher rates appear partly due to the Saudi economic boom. The Saudi fund manager said a pick-up in bank lending, rising inflation expectations and the stock market’s bull run, which has prompted banks to revive margin lending for securities investment, were all helping to push up interbank lending costs.
These factors could strengthen later this year. Bank lending to the private sector rose 12.1 percent from a year earlier in February, its fastest growth in 35 months. That was slower than the 27 percent expansion seen in the oil-boom year of 2008, but lending growth looks set to accelerate further; Bank of America estimates growth may be 15 percent for the whole of 2012.
Meanwhile, Saudi inflation edged up to a 14-month high of 5.4 percent in February, mainly because of higher food and housing costs, although it is still well below the record high of 9.9 percent recorded for 2008.
History suggests there is plenty room for short-term Saudi market rates to rise further above US rates; the spread of one-year SAIBOR over one-year LIBOR moved in a range of 25 to 30 bps for most of the first half of last year.
Much will depend on Saudi monetary policy. There are signs that authorities are keen not to let a build-up of excess liquidity fuel inflation; banks’ holdings of T-bills rose to 130.9 billion riyals in February from 126.0 billion riyals in January, the first rise since May last year.
“SAMA has stepped up its issuance of T-bills to mop liquidity and sterilize rising government spending,” Jean-Michel Saliba, analyst at Bank of America, wrote in a report.
However, any hike of official interest rates still appears far in the future, because the government’s economic policy since the Arab Spring is focusing so heavily on creating jobs and ensuring the growth needed to do so.
The official unemployment rate among Saudi citizens is 10.5 percent but that does not include a large number of working-age Saudis who are not counted as part of the labor force; the labor ministry estimated last month that over 1 million Saudis were receiving unemployment benefit. It estimates over 5 million jobs will need to be created by 2030 to absorb new job seekers.
Faced with this social and political challenge, authorities may be willing to accept relatively high inflation in exchange for growth. Several analysts said they did not expect any hike of official interest rates before the end of this year; Saudi riyal 9X12 forward rate agreements, which give the rate for a three-month deposit starting nine months from now, are quoted at around 86 bps, which does not imply any hike.
Jasser was quoted by Saudi media as saying this week that inflation had stabilized and would start declining.
“Inflation in Saudi is comparatively high. But it may not be high enough to need policy intervention,” said the Saudi fund manager.
“I think the government is very much concerned with unemployment at this stage and would want to improve infrastructure projects which would help reduce this in the long term.”