Saudis Struggle to Respond as Rising Libor Pressures Dollar Peg

(Bloomberg) -- Saudi Arabia is struggling with rising U.S. rates as it tries to strike a balance between boosting growth and averting capital flight that would put pressure on the riyal’s currency peg.

Saibor, a key Saudi interbank rate for riyals, rose on Monday above the central bank’s benchmark repurchase rate -- in theory its ceiling. That means the Saudi central bank, SAMA, could face renewed pressure to raise the repo rate to keep the riyal attractive for depositors who might otherwise be tempted to shift into dollars.

Saudi Arabia raised its benchmark rate on March 15 for the first time since 2009, preempting the U.S. Federal Reserve increase after Saibor fell below its equivalent London rate for dollars, posing a risk of capital flight.

The difference between Saudi’s three-month interbank offered rate and Libor has narrowed to 5 basis points since the Saudi rate increase, from 19 basis points earlier this month, the biggest gap in a decade. But the repo ceiling means the gap could widen again, leaving the central bank with some difficult choices.

“Saudi Arabia wants to keep rates low to boost economic growth, but doing so, they increase pressure on the riyal’s peg to the dollar,” said Mohamed Abu Basha, an economist at investment bank EFG-Hermes in Cairo. “It is justifiable that Saudi officials would want to skip matching the Fed’s rate increases, and they have been doing that, but there’s a limit to this policy. And I think they have hit that limit.”

Waiting it Out

Saibor has risen 36 basis points this year to 2.26 percent, above the repurchase rate of 2.25 percent. Libor, its equivalent London rate for dollars, has advanced 61 basis points since end-December to 2.3 percent on Tuesday.

“If Libor continues to rise, then SAMA has a decision to make: either raise the repo rate outside the Fed meeting cycle, or restrict liquidity and allow Saibor to climb above the repo rate,” said Ziad Daoud, the chief Middle East economist for Bloomberg Economics in Dubai. “We think it’d take a big jump in Libor to trigger an out-of-cycle hike.”

Saudi Arabia has been here before. During the previous episode of sustained Libor increases from 2004 till 2006, Saudi interbank rates did overshoot the repo rate, which lagged behind the U.S. Fed due to concerns over economic growth.

Saudis Struggle to Respond as Rising Libor Pressures Dollar Peg

“As things stand, raising rates again or restricting liquidity are difficult choices for SAMA given the still anemic economic backdrop in Saudi Arabia,” said Raza Agha, chief economist for the Middle East and Africa at VTB Capital Plc. “I suspect the Saudis may choose to wait before taking action.”

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