Global : Saudi Arabia is able to keep inflation in check

Global Investment House – Saudi Arabic Economic & Strategic Outlook – Saudi Stock Market–

As a result of movement towards monetary union, the Saudi Arabian Monetary Agency (SAMA) has maintained and is likely to maintain the Saudi Riyal peg to the US Dollar (1 US$= 3.75SR). The monetary union agreement covers common standards for economic and fiscal performance in the GCC, including a maximum level of the budget deficit, public debt, current account deficit, interest rates, and inflation.

Following the rise in the <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />US interest rates, SAMA, the Saudi central bank too raised the interest rates in the country. However, the central bank has significant foreign exchange reserves that it can use to maintain the parity in the foreign exchange markets. Saudi Arabian Monetary Agency (SAMA) raised interest rate on riyal by a quarter percent to 3.50 percent from 3.25 percent on deposits and on loans to 4.0 percent from 3.75 percent. This decision preceded a decision by the US Reserve Federal Bank to raise the interest rate on the dollar by a quarter of a percent. This maintained the Saudi repo difference of half a percentage point above the US Dollar interest rate.

Source: SAMA

The differential in the interest rates at the end of 2005 was about 0.502% in favor of the Saudi Riyal deposits for 3-month deposits reporting an increase from the differential of 0.044% reported at end of the previous year.  We believe that the interest rates are expected to increase further in the medium term. However, SAMA will continue to adjust its discounting rates with the Fed rates.

Looking at the quarterly growth, in the fourth quarter of 2005, broad money supply (M3) registered an increase of 3.1 percent. Recent economic conditions (including increase in economic growth, expansion in money supply, as a result of a great rise in bank credit) required the pursuit of a more tightened monetary policy. Therefore, SAMA raised Reverse Repo Rate twice in the fourth quarter of 2005 by 25 base points each from 4.25 percent to 4.75 at the end of the quarter. With the pursuance of tight monetary policy, and the rise in interest rates globally, inter-bank interest rates recorded a considerable increase during 2005. Inter-bank 3-month (SIBOR) interest rate went up from 3.73 percent at the end of the 1H-05 to 4.97 percent at the end of 2005.

Growth in money supply as measured by M3 was 11.4% in 2005 as compared to 19.1% reported in the previous year. The increase is mainly attributable to the growth in bank credit to the private sector by SR28.1bn. The strong advent of liquidity can be seen in the increase in the money supply at a CAGR of 13.4% over the period 2001-05. With the increase in the interest rates, Time and Savings deposits reported a strong yearly increase of 20.9% reaching SR165.2bn at the end of 2005. As a result the broad money supply registered a yearly growth of 10% in 2005 reaching SR448.8bn. With interest rate expect to inch up further in 2006, we expect more money being channeled in the bank deposit leading to further rise in money supply (M2).

Money Supply

Source: SAMA

Quasi-monetary deposits too reported a strong growth of 18.4% in 2005 which helped M3 to notch 11.4% growth aggregating to SR546.2bn at the end of 2005. This growth in the money supply came despite much of the wealth being diverted to the stock markets and other investment avenues such as real estate. However, with the recent correction in markets in 1Q06, we expect more money being channeled in the less-riskier asset classes such as bank deposits which will result in further growth in the money supply. The increase in the interest rate differential between the foreign exchange deposits abroad compared to the domestic interest rates will also act positively in getting back the investments made in foreign countries.

Inflation

Although the money supply and liquidity has increased in the last few years at an enormous pace, Saudi economy did not experience any major inflationary effects. Although we had expected inflation to show higher growth in our previous report on account of strong liquidity and high capital spending effect it did not happen and this can be attributed to the strict government policies of maintaining the prices at the desirable levels by matching the demand and supply of goods and services.

Inflation, as measured by the Consumer Price Index is estimated to have increased by 0.7% in 2005 while the non-oil GDP deflator has reported a yearly increase of 1.14% in 2005. We expect the government to keep its tight control over the price and expect inflation to remain in the range of 0.8%-1.5% in short term. However, as the Saudi Riyal pegged to the US Dollar, the movement  in inflation is influenced by the market movement of US Dollar. Also Saudi Arabia imports are expected to record more than 15% growth in next couple of years owing the strong growth experienced in the economy, any adverse movement in dollar can have a direct impact on the inflation.

Cost of Living Index - All Cities

Source: SAMA

As measured in Dec-2005, Foodstuff & Beverage recorded the maximum rise (+3.0%) as compared to the Dec-2004 levels. Other expenditure (+2.4%) and Home Furniture (+0.4%) too witnessed increase in the prices.  The sectors that saw decline in prices were Fabric Clothing & Footwear (-1.5%), Rent, Fuel & Water (-0.1%), Transport & Communication (-2.5%).  The strong decline in the transport and communication cost can be attributed to the lower communication cost due the increased competition in the telecom sector.

Wholesale Price Index

Source: SAMA

The Wholesale Price Index, which measures the movement in the average price of 160 sample items of various commodities and services sold in the wholesale market, registered a relatively higher increase of 1.71% at the end of 2005 as compared with 4.61% growth recorded in the previous year. With the exception chemical and related products, all the sectors recorded increase in their indices led by Other Commodities (5.2%), Food & Live Animals (+3.4%) and Vegetable oil (+1.9%).

The increase in the disposable income as a result of rise in the salary levels announced by the government can trigger some price increase in the Saudi economy. Although the government has done well in controlling prices in the past, we believe that it has its work cut out with regards to maintaining the price levels in future as well keeping in mind the strong increase in the income levels.