RIYADH, 24 September 2007 — Some analysts cast doubts on the recent decision taken by Saudi Arabian Monetary Agency (SAMA) to sustain the current Saudi riyal peg to the US dollar. But these analysts might have overlooked the fact that while the Kingdom’s central bank may have limited room to maneuver vis-à-vis interest rates, its hands are not totally tied.
First, Saudi riyal rates have been below US dollar rates for a considerable period due to high liquidity in the Kingdom, thus, giving it some wriggling room. In fact, the current negative spread is the untenable position because Saudi riyal rates historically have always been higher than dollar rates (around 40 bps) for standard reasons like country risk, emerging market risk, etc.
Maintaining a positive spread by SAMA in general is not difficult because markets expect this for emerging markets anyway, capital flows are not unlimited and banks and other financial institutions, in practice, always have country limits and sublimits when investing in emerging market assets (including loans).
Furthermore, SAMA has another policy tool in its arsenal, sterilization of speculative foreign capital inflows (by selling GDBs) — a short-term policy tool that was routinely used by the UK and Japan central banks in the seventies to simultaneously maintain a fixed currency and monetary independence.
On Aug. 17, the Fed cut its discount rate by 50 bps to 5.75 percent and extended the discount window operation by up to 30 days, after having pumped as much as $24 billion of funds into the market.
However, much to our expectations and liking, SAMA decided not to match the Fed’s interest rate cut. The SAMA statement cited “liquidity and the economic situation” as the reason, adding that it will take “appropriate” measures to deal with any impact of the decision. Presumably, this means the impact on the Saudi riyal peg to the dollar.
SAMA’s decision not to follow the US Fed enhances its credibility and reputation in the region further, especially considering that Kuwait, the UAE and Qatar decided to match the US cut, despite high domestic inflation. Kuwait’s move is particularly puzzling.
It pre-empted the Fed cut by first lowering its key interest rate 25 bps ahead of the Fed move and then cut the rate yet again by another 50 bps after the Fed announcement.
The UAE and Qatar central banks also cut interest rates (by 15 bps and 65 bps, respectively) and said that they will continue to match future US rate cuts. Again, this flies in the face of reality, namely, double-digit inflation driven by rents and property prices. Perhaps, they decided that revaluation pressures are a greater risk to avoid. Perhaps, they expect inflation to slow down as real estate supply comes on-stream to meet demand this year.
(Khan H. Zahid is chief economist and vice president at Riyad Bank in Riyadh.)
