The US Federal Reserve slashed its benchmark by three-quarters of a percentage point on Tuesday in an emergency bid to lend support to a US economy reeling from a mortgage crisis.
Saudi Arabia, which pegs its currency to the dollar, and where inflation hit a 16-year high of 6.5 percent in December, reduced the reverse repurchase rate by 50 basis points after a US rate cut, and raised banks’ reserve requirements to prevent lower borrowing costs from stoking inflation.
The Saudi Arabian Monetary Agency cut the reverse repo to 3.5 percent from 4 percent and left the benchmark repurchase rate at 5.5 percent, bankers said, reading from a central bank notice.
The central bank also raised the reserve requirement to 10 percent of deposits from 9 percent forcing lenders to keep more money in their vaults. It increased the reserve requirement on Nov. 1 for the first time in 27 years.
Kuwait cut its benchmark interest rate for the first time in 18 months. Kuwait’s 50 basis point cut came as a surprise. Unlike its neighbors which maintain a fixed dollar pegs, the country tracks a currency basket dominated by the dollar. The basket gives Kuwait more flexibility on interest rates and the central bank has left the benchmark discount rate steady since July 2006, fearing lower borrowing costs would stoke inflation which hit a record high of 6.2 percent in September.
The central bank had lowered the repo rate by 100 basis points since Sept. 12 to ensure investors betting on an appreciation of the dinar would not profit from better returns than they would get on US bank deposits.
The UAE cut its over-night repurchase rate by 75 basis points to 3.5 percent, matching a US rate cut. The repurchase rate was 4.25 percent on Tuesday, the central bank said. The repo, introduced in November, is the UAE benchmark and sets the rate at which banks borrow funds from the central bank.
“The appetite in the market for borrowing is huge and the effect of lower interest rates will make the appetite larger,” Saif Ali Al-Shehi, National Bank of Abu Dhabi’s senior general manager domestic banking, told reporters.
“To bring down inflation, the value of the dirham should increase by at least 30 percent gradually,” he said.
Qatar cut it deposit facility rate by 50 basis points but left its benchmark lending rate unchanged. The deposit rate fell to 3.5 percent while the benchmark lending facility rate was unchanged at 5.5 percent, a central bank official said. The repurchase rate was unchanged at 5.55 percent.
Bahrain slashed its benchmark one-week deposit rate by 50 basis points and left its lending rates on hold. It reduced the one-week deposit rate to 3.5 percent and cut its over-night deposit rate by 50 basis points to 3 percent but left the overnight repurchase rate and the overnight secured rate unchanged at 5.25 percent.
Moreover, Bahrain’s central bank raised bank reserve requirements to 7 percent from 5 percent. “The additional provisioning is aimed at strengthening management of excess liquidity in the banking system,” the central bank said in a statement.
Most Gulf states have negative interest rates, making it cheaper for people to borrow than to keep money in a bank deposit. “Negative interest rates have a tendency to support asset price inflation,” said John Sfakianakis, chief economist at SABB bank in Riyadh.
Investors maintained bets on currency appreciation in the Gulf, expecting the growing divergence between booming oil producers and a US economy reeling from a credit crisis to eventually sever the Gulf’s ties to the dollar.
“The region’s problem is that its economies have decoupled from the US, but economic policy is still tied because of the dollar peg,” said Simon Williams, regional economist at HSBC.
Bankers signaled just how difficult it was becoming for central banks to have their cake and eat it.
National Bank of Abu Dhabi said lower rates would allow it to lend 20 percent more this year in a country where inflation hit a 19-year high of 9.3 percent in 2006 on surging credit growth.
Banque Saudi Fransi complained that tumbling deposit rates had hurt profits by slashing returns from the money market, where banks were struggling to place funds as record oil revenues poured into the economy.
Kuwait’s Central Bank Governor Sheikh Salem Abdul-Aziz Al-Sabah acknowledged the dilemma, but said the gap between interest rates on dinar deposits and those of other currencies including the dollar had grown “unjustifiably high”.
Most Gulf states have negative interest rates, making it cheaper for people to borrow than to keep money in a bank deposit. “Negative interest rates have a tendency to support asset price inflation,” John Sfakianakis, chief economist at SABB bank in Riyadh.
Property prices are the main driver of inflation in much of the Gulf. Qatar, Oman and the UAE have imposed curbs on rent rises, but loan growth is driving demand.
