Saudi Arabia Economic and Strategic Outlook – Monetary Policy
Global Investment House – Kuwait – Saudi Arabia Economic and Strategic Outlook-Monetary Policy- In Saudi Arabia, the exchange rate plays a crucial role in monetary policy. It is an important variable for price stability and the balance of payments. Intervention policy under the fixed exchange rate regime is influenced by the level of foreign exchange outflow and the dollar/riyal interest rate differential. This will have direct effects (due to interest arbitraging) and indirect effects (via current account deterioration) on Saudi Arabia’s foreign exchange reserves. With perfect asset substitutability, a small change in interest rates results in a large change in reserves, reflecting the general point that there cannot be an autonomous monetary policy in a fixed exchange rate system with perfect asset substitutability.
In its exchange rate policy, SAMA takes into account the following elements: • Price Stability: In Saudi Arabia, monetary policy is tied to exchange rate policy. The policy objective is to maintain the dollar/riyal exchange rate as stable as possible so that public confidence is maintained and the inflow of capital is encouraged for domestic investment.
• Balance-Of-Payments Considerations: SAMA formally suspended the SDR link in May 1981 and has since maintained a de facto link to the dollar, with the last devaluation of the riyal occurring in June 1986 when its exchange rate against the dollar was adjusted from 3.65 to 3.75. In the 1980s, the balance of payments remained the overriding factor in exchange rate policy.
In 2006, SAMA continued to pursue its monetary policy geared to the objective of promoting stability in domestic prices and the exchange rate of the Riyal in addition to enhancing financial stability. To this end, it raised its repo and reverse repo rates, in two steps, from 4.75% and 4.25% to 5.00% and 4.50% in February 2006 and further to 5.20% and 4.70% respectively in June 2006.
In 2007, SAMA continued the same trend and repo and reverse repo rate were increased to 5.50% and 5.00% in February 2007. The repo rate remained at the same level then in 2007, however the reverse repo rate was changed from 5% to 4.25% in November 2007 and 4% in December 2007. Saudi reverse repo rate was trimmed down to 3.5% in January and 3% in February 2008.
In 2007, marked acceleration was witnessed in the domestic liquidity, with broad money (M3) registering a rise of 19.6% as compared with 19.3% in the preceding year. This was mainly due to substantial increase in government expenditure which exercised an enlarged expansionary influence on liquidity during the year. Among other factors influencing domestic liquidity, the increase in bank claims on the private sector slowed down to a third of its magnitude in 2005, reflecting the impact of prudential measures taken by SAMA in that year regarding personal loans. At the end of 2007, M2 growth stood at 23.7%, higher than that of 2006. However M1 growth remained a bit lower at 22.6%.
Interest rates in Saudi Arabia maintained their uptrend till 2006 and dropped slightly in 2007 in line with the general trend of interest rates in the international financial markets. The average interest rate for three month Riyal deposits rose by 1.26 percentage points to 5.02% in 2006 compared with the rise of 1.64 percentage points to 5.13% in the US dollar rate. However in 2007, the Riyal deposit rate dropped to 4.79% while in the same period the deposit rate in Dollar rose by 9 basis point to 5.22%.
In 2006, the monetary sector in the Kingdom widely benefited from the robust economic activity that translated into excess liquidity and recurrent strong foreign capital inflows and boosted foreign currency reserves at the central bank i.e. SAMA. Foreign reserves of the country doubled from US$17.6bn to US$31.32bn at the end of October 2007. Foreign exchange reserves held at the central bank are a very small fraction of the country's foreign assets. SAMA's net foreign assets (which include both FX reserves and fiscal reserves) increased in 2006 by an impressive 47.1% to US$221.4bn, equivalent to 64% of GDP. The largest increase was in investments in foreign securities, which reached US$166.8bn at the end of 2006.