The region’s policymakers have worked together since the spring to dampen speculation that record high inflation would force them to revalue the pegs to the globally weak dollar.
The dollar link generally obliges the Gulf central banks to track the Federal Reserve’s monetary policy, which has taken the U.S. benchmark rate to just 2 per cent via seven cuts in less than a year.
Yet Gulf central banks have effectively tightened policy using measures such as higher bank reserve requirements, and they are taking an active role in raising interbank rates while at the same time limiting the scope for currency speculation.
The 3-month Saudi Interbank Offered Rate has advanced more than 110 basis points in the last two months to 3.92 per cent, while the 3-month Emirates Interbank Offered Rate is up 76 basis points to 2.66 per cent.
"The liquidity that poured into the region in 2007 has actually gone away now because investors are not expecting a de-peg," said Jason Goff, head of treasury sales at Emirates NBD, the region’s biggest bank by assets.
"Nobody is selling dollars and buying dirhams and liquidity is now tight."
Interbank rates guide corporate borrowing costs across the Gulf, where demand for credit is soaring as the economies boom on a near six-fold rise in oil prices since 2002.
In the latest example, the Central Bank of Kuwait, the only Gulf state without a peg to the dollar, this week helped drive up the 3-month interbank rate by almost 40 basis points by withdrawing its guarantee of interbank transactions – a move that also made it more expensive to bet on the dinar.
"Higher interbank rates will feed into the cost of credit," said Simon Williams, regional economist at HSBC, who said that expectations the Fed will continue to hold rates this year have supported Gulf interbank rates.
Recent rate tightening has happened largely because currency speculators reversed bets that some Gulf states might follow Kuwait’s lead and revalue their currencies to fight inflation.
A flood of funds into Gulf currencies beginning in late 2007 left interbank markets awash with liquidity and pushed Saudi and UAE 3-month interbank rates to 4-year lows in April.
This, in turn, drove down corporate borrowing costs even as inflation hit at least 20-year high of 11.1 per cent in the UAE last year, and galloped to more than 10 per cent in Saudi Arabia this year. Since April, Gulf central bankers have worked together to reverse this trend primarily by insisting they would not drop their pegs or revalue before achieving a single currency plan.
