Capital inflows into the UAE, boosted by unrest in Bahrain, brought interbank offered rates to a seven-year low on Monday as liquidity stayed high in the Gulf Arab state's banking sector.
Bank deposits in the world's No.3 oil exporter rose in April to their highest level in at least two years. However, UAE banks are still hesitant to lend following Dubai's debt woes and weakness in the property sector.
"In the last quarter we have seen a substantial amount of liquidity returning to the region, from Gulf states into the UAE as well as international investors looking for carry," said Benoit Anne, head of emerging market strategy at Societe Generale in London.
"This has led to the fall in EIBOR as interbank dirham liquidity has improved substantially," he said.
Investors perceive the UAE - together with Qatar the only Gulf Arab states to have escaped regional unrest - as a safe- haven bet benefiting from inflows out of Bahrain, where Sunni rulers crushed weeks of protests led mostly by the Shi'ite majority demanding democratic reforms in March.
The small non-OPEC oil producer declared martial law and invited troops from Gulf neighbours to help quell the protests in a crackdown near Manama's financial district on March 16. Martial law was only lifted at the start of this month.
The benchmark UAE three-month interbank offered rate was set at 1.633 percent at Monday's fixing, the lowest level since June 2004 and down from from Sunday's 1.643 percent. The rate remains, however, well above the Saudi benchmark of 0.659 percent .
Before Dubai's debt crisis in November 2009, the rate was 1.915 percent.
Deposits at UAE banks stood at AED1.128 trillion ($307 billion) in April, up 2.1 percent from the previous month and 7.5 percent from December, when the turmoil in the Arab world started.
The UAE central bank had been urging banks to bring rates down and increase lending after September's $25 billion debt restructuring deal with Dubai World.
UAE private sector credit growth has been anaemic, at a mere 2.0 percent in February, compared to annual rates of well over 50 percent in the oil-boom year of 2008.
"I see UAE rates falling further. At the moment, the GCC (Gulf Cooperation Council) currencies are full of liquidity and the market is over-supplied," said Ali Askar, a senior foreign exchange dealer at Bahrain's Ahli United Bank.
The UAE has escaped public protests that challenged nearby Bahrain, Oman and Yemen. It pledged to spend $1.6 billion in less-developed northern emirates, introduced bread and rice subsidies and hiked military pensions among other measures.
Improved liquidity in the UAE, the second largest Arab economy, has been also helping push currency forwards down over the past three months.
"There is quite a lot of liquidity coming in from offshore. The FX swaps along the curve are much lower," said Lyndon Loos, head of forex trading for Middle East and North Africa at Standard Chartered in Dubai.
One-year dirham forwards were quoted at -6.5/1.5 points on Monday, compared with a peak of 45 points at the beginning of March. Forwards now imply the dirham will hold close to its 3.6725 peg to the dollar over a one-year period.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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