Saudi Central Bank to Drain Liquidity to Counter Libor Rise

(Bloomberg) -- Saudi Arabia's central bank plans to drain excess liquidity from the banking system to mitigate pressure on the riyal's peg to the dollar as U.S. interest rates rise, Governor Ahmed Abdulkarim Alkholifey said.

The Saudi Arabian Monetary Authority, as the central bank is known, will allow some deposits placed with commercial banks in 2016 to mature without rolling them over, he said, boosting a key interbank rate for riyals that has lagged Libor, its London equivalent for dollars, and raised the prospect of capital flight.

“Some amounts of deposits are maturing in the banking system,” Alkholifey told Bloomberg in Washington, where he attended the International Monetary Fund and World Bank spring meetings. “We'll let them mature and they will be back to the central bank instead of the banking system, and this will siphon off the liquidity to the system.”

Climbing U.S. borrowing costs pose a dilemma for SAMA, which must strike a balance between overcoming the worst economic slowdown since the global financial crisis a decade ago and maintaining its currency peg to the dollar.

Though it has tracked U.S. Federal Reserve decisions through its reverse repurchase rate, Saudi Arabia had, until last month, avoided raising its benchmark repurchase rate due to concerns this would stifle growth. It pre-empted the Fed by raising its benchmark rate on March 15 for the first time since 2009 after the Saudi rate, Saibor, fell below Libor.

The resulting increase in borrowing costs is pressuring companies already squeezed by weaker buying power among Saudis this year due to higher taxes and lower subsidies. Ahmed Abou Doma, CEO of the kingdom's second-largest telecom company, Mobily, said his firm has put hedging mechanisms in place to protect against rising rates.

Currency Pressure

The interbank rate is important because investors could turn away from Saudi assets if the yield becomes too low compared to what is available elsewhere, putting pressure on the currency.

“In order to protect the exchange rate arrangements that we have at this time, we have to keep under our eyes what is the difference between Libor and Saibor,” said Alkholifey.

The difference between Saudi Arabia's three-month interbank offered rate and Libor has narrowed to 1 basis point since the Saudi rate increase, from 19 basis points last month, the biggest gap in a decade.

But analysts have said that SAMA would have to take further measures to soak up excess liquidity and push its interbank rate above Libor to avert the potential risk of capital flight.

SAMA can “adjust liquidity available in the system to push rates higher, but that's only good for fine tuning, and has a ceiling,” said Mohamed Abu Basha, head of macro analysis at regional investment bank EFG-Hermes in Cairo. “So it is inevitable that they will adjust interest rates directly.”

No Fear

Alkholifey said banks were also reducing the amounts they park at the central bank through its reverse repo facility, helping to support the interbank rate, adding that scaling back on deposits in banks should be enough to close the remaining gap, “which is what we want.”

In any case, the bank has no fear of capital outflow and has no intention of changing its exchange rate arrangements.

“Fundamentals are good. The banking sector is strong and liquid and still profitable,” he said. “So, we don't fear any capital outflow as we speak.”

--With assistance from Vivian Nereim and Ahmed Feteha

To contact the reporter on this story: Onur Ant in Ankara at oant@bloomberg.net.

To contact the editors responsible for this story: Lin Noueihed at lnoueihed@bloomberg.net, Mark Williams

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