RIYADH, 1 October 2007 — A recent report of the Deutsche Bank warned that differences in Saudi and US interest rates on a long term basis would trigger severe liquidity problems as a side effect of the profuse capital flow to the Kingdom and huge reserve buildup there. On the other hand, Dow Jones News Service pointed out that the gap between the interest rates of the two countries would deepen the inflationary problems in the Kingdom in an unprecedented manner.
These reports were spurred by Saudi Arabian Monetary Agency’s (SAMA) dismissal of the speculation that it planned to revalue the riyal against the US dollar. Recently the value of riyal rose to a 21-year high at SR3.735 against the dollar, spawning rumors of ditching its dollar peg. SAMA authorities categorically stated recently that the stability of the currency is vital for investors and the riyal would not be disturbed unless the dollar suffers a serious downfall, the business daily Al-Eqtisadiah reported yesterday.
The difference in the interest rates of riyal and dollar became conspicuous after the US Federal Reserve cut the interest rate by a quarter point last week. According to Deutsche bank report, the Saudi decision to stick to its old interest rates contrary to the US decision would increase the pressure on riyal to appreciate against other currencies. Another inevitable ramification is the rising inflation in the Kingdom. In August, inflation rates raced to an unprecedented 3.8 percent. Until Saudi Arabia adopt an independent monetary strategy, the current upheavals in the dollar market would spur the capital inflow in the Kingdom.
The inflow would result in a sharp rise in the money base. The money base rose sharply in the Kingdom recently. The 25.2 percent rise in the money base in December doubled in six months to reach 55.2 percent in July. Contrary to what happened in Kuwait and the UAE where the foreign net assets accumulated without any insulation mechanism, in Saudi Arabia the assets were paid in deposits at SAMA. The rising liquidity problem may cross the limits set by SAMA.