JEDDAH, 24 May 2006 — Despite a fast increase in the money supply and liquidity over the last few years, the Saudi economy has not experienced any major inflationary effects. Inflation, as measured by the Consumer Price Index (CPI) is estimated to have increased by 0.7 percent in 2005 while the non-oil GDP deflator reported an increase of 1.14 percent in 2005, according to a report by the Kuwait-based Global Investment House (Global).
However, as the Saudi riyal is pegged to the US dollar, the movement in inflation is influenced by the market movement of the US dollar. Also Saudi Arabian imports are expected to record more than a 15 percent growth in the next few years owing to the strong growth experienced in the economy and any adverse movement in the dollar can have a direct impact on the inflation.
As a result of movement toward monetary union, the Saudi Arabian Monetary Agency (SAMA) has maintained the Saudi riyal peg to the US Dollar (1 US$= SR3.75). The monetary union agreement covers common standards for economic and fiscal performance in the Gulf Cooperation Council (GCC), including a maximum level of the budget deficit, public debt, current account deficit, interest rates, and inflation.
Following the rise in US interest rates, SAMA too raised interest rates in the country. However, the central bank has significant foreign exchange reserves that it can use to maintain the parity in the foreign exchange markets. SAMA raised interest rate on riyal by a quarter percent to 3.50 percent from 3.25 percent on deposits and on loans to 4.0 percent from 3.75 percent. This decision preceded a decision by the US Reserve Federal Bank to raise the interest rate on the dollar by a quarter of a percent. This maintained the Saudi repo difference of half a percentage point above the US Dollar interest rate.
The differential in the interest rates at the end of 2005 was about 0.502 percent in favor of the Saudi riyal deposits for 3-month deposits reporting an increase from the differential of 0.044 percent reported at end of the previous year. The Global report said that the interest rates are expected to increase further in the medium term. However, SAMA will continue to adjust its discounting rates with the Fed rates.
Looking at the quarterly growth, in the fourth quarter of 2005, broad money supply (M3) registered an increase of 3.1 percent. Recent economic conditions (including increase in economic growth, expansion in money supply, as a result of a great rise in bank credit) required the pursuit of a more tightened monetary policy. Therefore, SAMA raised Reverse Repo Rate twice in the fourth quarter of 2005 by 25 basis points each from 4.25 percent to 4.75 at the end of the quarter. With the pursuance of tight monetary policy, and the rise in interest rates globally, inter-bank interest rates recorded a considerable increase during 2005. Inter-bank 3-month (SIBOR) interest rate went up from 3.73 percent at the end of the first half of 2005 to 4.97 percent at the end of 2005.
The growth in money supply as measured by M3 was 11.4 percent in 2005 as compared to 19.1 percent in the previous year. The increase is mainly attributable to the growth in bank credit to the private sector by SR28.1 billion. The strong advent of liquidity can be seen in the increase in the money supply at a CAGR of 13.4 percent over the period 2001-05. With the increase in the interest rates, time and savings deposits reported a strong yearly increase of 20.9 percent reaching SR165.2 billion at the end of 2005. As a result the broad money supply registered a yearly growth of 10 percent in 2005 reaching SR448.8 billion. Quasi-monetary deposits too reported a strong growth of 18.4 percent in 2005 which helped M3 to notch 11.4 percent growth aggregating to SR546.2 billion at the end of 2005.