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Gulf central banks may store trouble with loose policies

Gulf central banks may store trouble with loose policies

Ultra-low interest rates contrast with strong growth as the IMF warns that Gulf needs to be ready to adjust policy but weak markets and private sector growth need low rates.

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November 10, 2011 4:44 by



In April this year, with the economy growing at an annual clip of at least 15 percent, Qatar’s central bank cut key interest rates by at least half a percentage point. In August, as domestic credit expanded at a nearly 20 percent rate, it cut them again.

Across the six oil-rich economies of the Gulf, central banks are running loose monetary policies that contrast sharply with their strong economic growth.

Saudi Arabia is holding its key interest rate at 2 percent, after cutting it to that level during a near-recession in 2009, even though gross domestic product growth has rebounded to a projected 6.2 percent this year, according to a Reuters poll of analysts.

The United Arab Emirates’ repo rate is at 1 percent — lower than the troubled euro zone’s benchmark rate — although growth this year is expected to be 3.8 percent.

Meanwhile, Gulf countries have loosened fiscal policy this year, ramping up social spending to head off social unrest after regime changes elsewhere in the Arab world. Saudi Arabia has announced $130 billion of extra spending, which is expected to be spread over several years; while Oman is boosting 2011 budget spending by over 10 percent from its original plan, and intends to keep spending at a similarly high level next year.

Over the long term, it is a potentially explosive policy mix — and some economists are starting to think Gulf central banks risk storing up trouble for the future, in the form of inflation or asset bubbles.

The International Monetary Fund (IMF) said last month that the region’s accommodative monetary policy was still appropriate, but warned that “policymakers should stand ready to adjust fiscal and monetary policies should inflationary pressures or credit bubbles emerge.”

“Over the longer horizon, fiscal and monetary policy should be redesigned to enhance the ability to smooth consumption and absorb shocks, safeguard long-term sustainability, and bolster financial stability,” the IMF said in its twice-yearly Middle East and North Africa outlook.

CURRENCY PEGS
The Gulf countries have solid reasons for loose monetary policy. All of them peg their currencies to the US dollar, except Kuwait which bases the value of the dinar on a dollar-dominated basket of currencies.

With the United States keeping its interest rates ultra-low, the Gulf will risk destabilising inflows of speculative “hot money” if it lets too big a gap develop with its own rates.

That seemed to be a motive behind Qatar’s rate cuts this year; the August cut came one day after the US Federal Reserve publicly pledged to keep its rates near zero for at least two more years. The Qatari central bank wanted to curb inflows of speculative capital, local media quoted the governor as saying.

But there is a deeper reason for loose policies around the region: unlike economic growth, stock and real estate markets have not recovered from the slump of 2008/2009. Dubai’s stock market index is near its lowest level since 2004; firms across the Gulf are still struggling to restructure debts after running into trouble in 2009, and analysts say Dubai residential property prices have not finished falling. Weak global markets are also hurting Gulf asset prices.

“If you look at the market performance in the UAE and across the region, whether due to company earnings, political or global risks, we still have depreciation in asset prices. I don’t see in the short- or mid-term any risk to the loose policies,” said Mahdi Mattar, chief economist at CAPM Investment in Dubai.

Weak asset prices underline another problem for the central banks. Although all the countries aim to diversify their economies, boost the role of the private sector and reduce their reliance on oil and gas, much or most of this year’s growth has been based on…(CONTINUED TO NEXT PAGE)



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