Money market rates in the United Arab Emirates hit their highest levels in roughly two years on Tuesday as low oil prices slashed state oil revenues, leaving banks with less money to lend.
The economies of the rich Gulf Arab oil exporters have so far coped well with the plunge of crude prices since last year. Heavy government spending and strong activity in sectors other than energy have kept economies growing solidly.
But a jump in the UAE's short-term market interest rates over recent weeks - mirrored to varying degrees in the other oil exporters - is a threat.
As governments' oil income shrinks, they are making fewer new deposits in their banking systems, reducing banks' supplies of excess cash. This is forcing up the cost of money and could eventually hurt economies by making loans to corporations and stock market investors scarcer and more expensive.
One-year money was offered at 1.180 percent among UAE banks on Tuesday, up from 1.157 percent at the end of last month and 1.081 percent at the end of June. The rate was at its highest since January 2014.
The overnight interbank rate, which hovered around 0.10 percent for the first eight months of 2015, shot up to 0.46 percent this week - its highest since at least mid-2013 - before easing back to 0.38 percent on Tuesday.
"Interbank rates have risen in response to tightening liquidity in the banking sector. Liquidity has fallen with a sharp deceleration in deposits, with government deposits in the banking sector falling on the back of weaker oil prices," said Monica Malik, chief economist at Abu Dhabi Commercial Bank.
A UAE money trader said the prospect of going without lavish deposits of oil money for the first time in several years was worrying some banks. "Banking system risk perception has changed, hence smaller banks have started quoting higher fixing rates. This is de facto monetary tightening," he said.
Total deposits at banks rose only 0.7 percent between the end of 2014 and August, while domestic bank lending increased 5.7 percent, the latest central bank data shows.
So far, rising deposits by non-residents have partially offset falling government deposits and sluggish growth in residents' deposits. Liquidity could tighten further if capital leaves the UAE in response to any slowdown of the economy and markets - apartment prices in Dubai have fallen 11 percent in the past 12 months, consultants JLL said on Tuesday.
Reflecting this possibility, the UAE dirham is under pressure in the forwards market; one-year U.S. dollar/dirham forwards rose as high as 120 points on Tuesday, their highest level since December 2009.
So far the UAE central bank has not made a public statement about the tightening of liquidity, and it declined to comment when contacted by Reuters. However, the chief executive at a UAE-based bank said the central bank had discussed the situation with commercial lenders in September.
"The central bank is watching the liquidity situation, especially the impact on small banks, and may step in when needed," he said.
With assets in its sovereign wealth funds estimated at near $1 trillion, the UAE has plenty of money that it could bring home if necessary to ease any liquidity crunch.
But with the U.S. Federal Reserve preparing to tighten policy, it may be difficult for the UAE central bank to wrestle local market rates back down, even if it decides to do so.
The dirham's peg to the dollar means the UAE has little room to conduct an independent monetary policy. Rate hikes in the United States would probably have to be imitated in the UAE to avoid capital outflows, according to a local banker familiar with the central bank's thinking.For all the latest banking and finance news from the UAE and Gulf countries, follow us on Twitter and Linkedin, like us on Facebook and subscribe to our YouTube page, which is updated daily.
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