JEDDAH, 10 February 2007 — The Saudi Arabian Monetary Agency (SAMA) on Thursday unexpectedly tightened monetary policy, narrowing the gap with US interest rates for the first time in seven months to address inflation.
The central bank raised the benchmark repo rate and the reverse repo rate by 30 basis points to 5.50 percent and five percent respectively, traders in Riyadh and Dubai said, citing a memo sent to Saudi banks.
SAMA, which keeps the riyal pegged to the dollar, was making up ground lost in 2006 when it declined to match the US Federal Reserve’s interest rate increases during a Saudi stock market crash that began in February.
Saudi Arabia and five other Gulf Arab states have pegged exchange rates to the dollar in the run-up to monetary union. Most Gulf central banks move in tandem with the Fed to maintain their currency’s yield appeal.
Economist Abdul Wahab Abu-Dahesh said SAMA took the measure to increase rates to combat inflation in the economy as a result of increase in prices.
“The inflation came as a result of increase in international prices. The exchange rate of Saudi riyal is stable against the US dollar and other currencies, thus we are importing inflation,” Abu-Dahesh said.
According to him, the present increase in rates would not help much in dealing with inflation as long as international prices remain high. He said the SAMA move would make loans more expensive.
“As a result production costs will increase and prices of products will go up,” he said.
Speaking to Al-Watan Arabic daily, he said the new move would strengthen the Kingdom’s monetary market at the expense of the stock market because investors would gain more profits from the former than from the latter.
Saeed Al-Shaikh, chief economist at National Commercial Bank, said SAMA increased the rates as a result of an increase in the interest rates of US dollar.
“Last year the interest rates on dollar rose by 25 points but SAMA did not increase the rates on the riyal in the wake of stock market plunge,” he pointed out.
Al-Shaikh also believed that SAMA might have taken the decision in order to deal with inflationary pressure. Last year the central bank had acknowledged that inflation rates in the Kingdom were going up.
“The move is pretty much one of catch-up with US rates,” said Shahin Wallee, currency strategist at BNP Paribas in London.
US interest rates stand at 5.25 percent after 17 consecutive quarter point increases that ended in June. The Saudi central bank moved out of step with the Fed early in 2006 as the stock market crashed.
While SAMA has never linked monetary policy to share prices, a spell of relative calm on the bourse in June allowed the central bank to match the last Fed hike, analysts said at the time.
The market, the Arab world’s largest, then tumbled again, losing more than half its value and ending 2006 as the worst performer among 81 bourses tracked by Birinyi Associates Inc. a US research firm.