Ultra-low interest rates amid sharp economic growth is a potentially explosive policy mix
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
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
The United Arab Emirates' repo rate is at 1 percent - lower
than the troubled eurozone'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 $130bn 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.
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.
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"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 high oil prices and government
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.
An 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."
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Qatar's inflation has been trending up this year, to 2.2
percent in September from 1.6 percent in January, and the 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 - 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, so central banks would
probably have to absorb funds with issues of certificates of deposit or
"The central bank in Saudi was active when the bonuses
for public sector workers were paid earlier this year. You saw fairly
aggressive issuance of Treasury bills in order to mop up liquidity in the
banking sector," Gamble said.
Qatar's central bank has been issuing T-bills with
maturities ranging from three to nine months to drain excess liquidity from the
Central bank governor Sheikh Abdullah bin Saud al-Thani said
last week that he had no plan to raise monthly issuance from the current SR2bn ($550m)