In an effort to protect the riyal’s peg to the US dollar over the coming years, the Saudi Arabian Monetary Authority (SAMA) will hike interest rates in line with the US Federal Reserve, according to a new outlook report by BMI Research.
The report predicts that price pressures, driven by fiscal consolidation measures, will increase in 18, but the tightening cycle will do little to mitigate these pressures, as demand-pull inflation will remain subdued. Although the tightening cycles will also weigh on credit demand, BMI maintains its views that the liquidity squeeze is “largely over.”
BMI forecasts two 25 basis point (bps) hikes in Saudi Arabia’s reverse repo rate (SAMA’s main policy rate) in 2018, which would maintain the current rate differential with the US Fed unchanged. By the end of 2018, this measure will take SAMA’s reverse repo rate to 1.75 percent.
“Although pressures on the riyal’s peg to the US dollar have significantly increased since January 2016, owing to the gradual recovery in oil prices, we still believe that an decision by SAMA to not follow closely the Fed’s hiking cycle would result in renewed investor concerns over its willingness to support the peg,” the report notes.
“The rationale to protect the peg remains strong, given that oil accounts for the vast majority of exports, and due to the kingdom’s reliance on imported consumer and capital goods,” it adds.
Additionally, BMI forecasts inflation to average at 3.3 percent throughout the year, up from a projected inflation of 0.4 percent in 2017. The introduction of VAT at a rate of 5 percent, coupled with reductions in energy subsidies, will push prices higher in 2018.
“That said, we believe that rising interest rates will have a limited impact on inflation, given that demand-pull inflation remains low owing to the weak domestic demand, and the government’s decision to delay subsidy cuts initially planned for July 2017,” the report says.
“Inflation averaged -0.4 percent year over year over January-August 2017, owing to weak domestic demand and the government’s decision to delay subsidy cuts.
“Given our expectation for economic activity to remain subdued in 2018, demand-pull prices pressures will stay modest over the coming quarters,” it adds.
With regards to credit, BMI notes that credit growth came in at -1 percent year-over-over in August, the sixth consecutive month of negative growth. BMI forecasts that rate hikes will limit recovery growth.
However, DMI predicts that liquidity pressures will remain “manageable”, as demonstrated by M3 money supply having returned to positive growth since October 2016, and that the government’s reliance on international debt markets – such as the issuance of a $12.5 billion Eurobond in September – will continue to support liquidity.
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