The Central Bank of Kuwait (CBK) raised the discount rate by 25 basis points to 6.25% in the first week of July 2006. This was the first such rise since November 2005. Central Bank Governor Sheikh Salem AbdulAziz Al-Sabah informed that the decision was in-line with the CBK’s goal of enhancing the competitiveness of the Kuwaiti Dinar. Since 2004, the CBK has raised domestic interest rates broadly in-line with climbing US rates. However, the increases have been smaller and slower than those in the US.
The rising interest rates in the recent years have not been able to douse liquidity to a great extent. During 2006, money supply (M2) has increased throughout the year with the exception of June and July. During the months of June and July 2006, money supply posted declines of 1.03% and 1.49% respectively. Moving ahead, M2 continued its growth registering 2.82% monthly growth during November, following 0.65% growth registered in October. At the end of November, M2 increased to KD15.78bn as compared with KD15.35bn at the end of previous month. The money supply expanded by 20.57% over the first eleven months of 2006, as compared to 12.3% growth rate for the whole of 2005. In terms of y-o-y growth, M2 at the end of November 2006 was 14.9% higher than the corresponding period in the previous year.
The main factor behind the increase in M2 during 2006 was the increase in Quasi-money. Quasi-money increased by 30.5% during first 11 months of 2006, after growing by 10.4% in 2005. Quasi money, which represented more than 77% of M2, increased to KD12.21bn at the end of November 2006 as compared to KD9.36bn reported in December 2005. The growth in quasi money picked up in 2004 after a stagnation in its growth rates during 2002 and 2003. This was mainly the result of its positive relation with interest rates as rising interest rates have prompted many to re-direct funds into KD and foreign currency deposits.
The demand for loans in the private sector, a key yardstick for money supply growth, continued to pick up in 2006. Claims on the private sector expanded at 20.9% during the first 11 months of 2006, led by 25.1% rise in credit facilities to residents. On Y-o-Y basis, claims on the private sector expanded at 23.7% at the end of Nov’06. Continuous increase in demand for loan despite the increase in interest rates is testimony to the robust demand in the economy. On the other hand, claims on the government increased marginally by 3.5% during the first 11 months of 2006.
It is possible that the lagged effect of the tightening monetary policy adopted by the CBK will show more impact in coming months. CBK is using a variety of tools such as hiking interest rates or floating treasury bonds to conduct its monetary policy. We expect that the CBK might raise its discount rate during the next few months. This is especially after the latest appreciation in KD exchange rate against US$ by 1% (reaching 289 fils/US$ from 292 fils/US$), thus exhausting the allowed margin of movement around the parity rate.
There has not been any substantial bond issuances by government since 2001. In fact, there has been a decline in the outstanding government borrowing since 2003, after a marginal increase in 2002. During the first eleven months of 2006, outstanding government borrowings have come down by 4.6%. This is due to the fact that government coffers are continued to increase due to high oil prices thus providing a cushion for lower government borrowings. At the end of 2005, T-Bill balance was nil. It is important to note that the preference of T-Bond balance over T-Bill supports the government trend to substitute its re-financing strategy away from short term to medium term. In coming days, it is highly likely that outstanding government borrowing will come down as relatively high oil prices should continue to boost government coffers.
Following the rising interest rates environment since 2004, interest rates in the Kuwaiti banking system have been climbing in 2006 too. However, interest rates increased at lower growth rates as compared to those of 2005. Average lending rate increased to 8.75% in November 2006, up from 7.50% for 2005. Similarly average deposit rates increased to 5.36% in November 2006, up from 3.47% for 2005. Deposit rates have grown faster than the lending rates. All major interest rates in the Kuwaiti banking system showed higher growth rates as a direct consequence of CBK discount rate hike on 3rd July. Average inter bank rates also continued to increase in 2006. The 12-month KIBOR rate increased to 6.41% in November 2006, up from 4.2% reported for 2005.
During 2006, the month of July witnessed CBK hiking its discount rate for the only time in 2006 as against Fed’s four consecutive interest rate hikes that totaled 100 basis points since January. The Fed hiked its fund rate on January, March, May and June by 25 basis points each to stand at its current level of 5.25%. CBK raised its rate by 25 basis points to 6.25% in July’06. This latest hike in CBK discount rate was expected, as pegging the Kuwaiti Dinar exchange rate to the US$ within specified ±3.5% margin calls for maintaining the interest rate on the KD in parallel with major international currencies. As a result of the discount rate hikes, the differential between the KD and US rates witnessed a downward trend to reach a low of 1% in 2006.
There is further possibility of another hike in CBK’s discount rate, especially in case the US Fed hikes its rate. The CBK Governor has confirmed the CBK's keenness on using the monetary policy instruments at its disposal, in a preventive and gradual way, in order to further firm up the atmosphere contributing to the enhancement of monetary stability in the national economy. Moreover, interest rates are on its upward trend internationally especially in the Euro-zone and USA. For the Euro-zone, following its latest interest rate hike during October, the European Central Bank hiked its rate by another 25 basis points to 3.5% during December’06. On 11 January 2006, the Bank of England surprised markets by raising interest rates a quarter percentage point to 5.25 percent, saying the economy had less spare capacity and price pressures were increasing. As for US Fed, the latest Federal Open Market Committee’s (FOMC) meeting, during December’06, kept its benchmark fund rate unchanged for the fourth consecutive meeting, leaving it at 5.25%. The decision was on account of Fed’s view that going forward the economy seems likely to expand at a moderate pace. Federal Reserve noted that economic growth has slowed over the course of the year, partly reflecting a cooling of the housing market. Federal Reserve also noted that inflation pressures seem likely to moderate over time, reflecting reduced impetus from energy prices, contained inflation expectations, and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.
