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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.

November 10, 2011 4:44 by

…high oil prices and government spending.

Although growth in bank lending to the private sector hit a 28-month high of 9.2 percent in Saudi Arabia in August, it is only just recovering from levels below 5 percent which prevailed last year. Bank lending growth in the UAE accelerated to at least an 18-month high of 3.5 percent in September, but that is still below the projected rate of GDP growth.

“One reason that governments have kept interest rates so low currently is because they want to stimulate more bank lending,” said Paul Gamble, head of research at Jadwa Investment in Riyadh. “As the banks are not really lending, the effect of very low interest rates is not being transmitted into the economy.”

The euro zone crisis may be worsening the problem. About 50 percent of cross-border syndicated lending in the Middle East and North Africa has come from European institutions in recent years, said V. Shankar, Standard Chartered’s chief executive for Europe, the Middle East, Africa and the Americas.

“Many European banks are now shrinking their new business.
“What it means for a lot of corporates, who are in good shape, is that they will need to curtail their ambitions,” he said.

That may be prompting central banks to keep interest rates extremely low in an effort to stimulate the private sector, even though overall growth in the economy is strong.

So far, with the exception of Oman, where consumer price inflation climbed to a 29-month high of 5.3 percent year-on-year in August, there is little sign of inflationary pressures building in the Gulf.

The latest Reuters analyst poll, in September, predicted Saudi Arabian inflation of 5.1 percent this year and 5.0 percent next year — still well below the double-digit rates seen during the oil boom of 2008. Inflation in the UAE is projected at 2.0 percent and 3.0 percent, respectively.
But because of the currency pegs to the greenback, these calculations could change quickly if the US currency enters an extended depreciation globally as a result of a prolonged US low-rate policy.

“I don’t think (inflation) pressures will mount in 2012, but central banks may need to be more closely monitoring their inflationary dynamics,” said Andrew Gilmour, senior economist at Samba Financial Group in London.

“The country to look at in that context would be Qatar, which is pushing ahead with an ambitious infrastructure and development programme, and there is a potential for price pressures by 2013 if US rates are still low. In this context Qatar might be looking to tighten.” Qatar’s inflation has been trending up this year, to 2.2 percent in September from 1.6 percent in January, and the Reuters poll forecast full-year rates of 2.7 percent in 2011 and 3.5 percent in 2012.

Similarly, while asset bubbles in the Gulf have not begun reinflating, they could do so if governments’ expansive fiscal policies convince Gulf investors that markets have bottomed out and cause funds to flow back out of bank deposits.

Gabriel Sterne, a senior economist at Exotix in London, said one candidate for an asset bubble could be Saudi Arabia’s real estate market, because government spending was focusing on property development.

“In the GCC countries, where excess liquidity in the banking system is ample…a change in the willingness to lend could spark a rapid pickup in credit growth,” the IMF said.

If asset markets and inflation start to surge in the Gulf and central banks are unable to hike rates because of a low US rate policy, they are likely to resort to draining excess funds from the banking system — a strategy followed with limited success this year by fast-growing economies in Asia.

“If they don’t start to control liquidity, it might create a vicious cycle. For the time being, this is not the case, but it is something to watch out for,” CAPM Investment’s Mattar said.

In highly developed markets, central banks can adjust liquidity through money market operations that involve a wide range of debt instruments. In the Gulf, debt markets are not nearly as deep or diversified and monetary operations are not as sophisticated…(CONTINUED TO NEXT PAGE)

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