20080123_efg_010220 by suchenfz

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									                                             gcc economics
                                             Further Into Negative
                                                                                                                         23 january 2008


                                             economics flash note

                                           • Emergency and Aggressive Fed Cuts Ahead of Open Market Committee Meeting: The US Federal
                                           Reserve cut the Fed Fund Target Rate (FFTR) by an aggressive 75 basis points (bps) to 3.50% yesterday in
                                           an attempt to stave off recession and in reaction to sharp stock market declines on Wall Street and around
                                           the globe. The Fed cited a weakening economic outlook and increased downside risks to growth as the
                                           main reasons for the cut. Data out of the US has been particularly weak recently, especially on the
                                           employment front, and the fall in stock markets has the potential to further dampen confidence, and
                                           reduce private consumption and investment.

                                           • GCC Follows: Given the GCC currency pegs to the USD, regional countries have had to closely track US
                                           interest rate moves, although the differential between US and GCC interest rates has varied historically.
                                           The GCC countries have continued to follow US rate cuts to some degree, although, as in 2007, the
                                           responses by the GCC central banks have varied.

                                           • UAE Matches the Fed: The UAE central bank matched the Fed by cutting the repurchase (repo) rate
                                           (central bank's lending rate to commercial banks) by the full 75 bps to 3.50% today. The benchmark repo
                                           rate has been kept in line with the US FFTR since December.

                                           • Kuwait Cuts by Lower Amount: Kuwait reduced rates by a lesser 50 bps bringing its discount rate (the
                                           benchmark lending rate) to 5.75% and the repo rate (the benchmark deposit rate) to 4.00%. This was after
                                           Kuwait left its benchmark rates unchanged in December after the Fed cut by 25 bps. Kuwait has the
                                           greatest degree of monetary policy flexibility within the GCC, given that the KWD is pegged to a currency
                                           basket rather than to the USD. Since September, when the US started cutting the interest rate, Kuwait has
                                           reduced its repo rate by 150bps (compared to 175 bps in the US) and its discount rate by just 50 bps.
                                           Kuwait indicated that it has cut lending rates to keep them in line with market rates and to avoid any
                                           systemic risk linked with the higher central bank lending rate.

                                           • Saudi Arabia, Bahrain and Qatar Cut Deposit Rates by 50 bps: Saudi Arabia, Bahrain and Qatar
                                           continued their policy of reducing the reverse repurchase (deposit) rate, while holding the repurchase
                                           (lending) rate on hold. The Saudi Arabian Monetary Agency (SAMA) also cut the reverse repo rate by a
                                           lesser 50 bps to 3.5%, whilst keeping the repurchase rate at 5.5%. In addition, SAMA raised the commercial
                                           banks’ reserve requirement with SAMA to 10% of deposits from 9% previously. In November, the central
                                           bank raised the reserve requirement for the first time in 27 years from 7%. Increasing the reserve
                                           requirement is a form of monetary tightening as it reduces liquidity in the banking system as well as the
                                           lending base of the commercial banking sector.

                                           Bahrain moved in line with Saudi Arabia, cutting its benchmark rate by 50 bps (overnight to 3.0% and one-
                                           week to 3.5%) but leaving its lending rates on hold at 5.25%. Qatar also reduced its benchmark deposit
                                           rate by 50 bps to 3.5%, while the repo rate was left unchanged at 5.5%.

                                           • Real Interest Rates even more Negative: Real interest rates in the GCC were already negative and
                                           today’s rate cuts will place them further into negative territory. Moreover, the Fed clearly hinted that
                                           further rate cuts are likely to come, which will result in additional interest rate cuts in the GCC. The fact
                                           that a number of GCC countries reduced rates by a lower amount and/or kept lending rates on hold
                                           highlights that following the US’ aggressive cuts are painful and that local central banks are trying to
                                           reduce the degree of monetary loosening. The US rate cuts illustrate just how out-of-sync the GCC and
                                           the US economies are, with the GCC economic fundamentals remaining strong. Interest rates are too low
                                           given the level of economic activity on the ground and credit growth and liquidity in the banking sector
                                           will remain strong in the GCC. These factors will continue to add to the inflationary environment.

                                           Although some GCC central banks have been keeping lending rates on hold in an attempt to reduce the
                                           monetary stimulus of the interest rate cut, this policy will have only a limited impact on stemming credit
                                           growth. Firstly, given the strong level of liquidity in the banking sector, borrowing from the central bank is
                                           limited. Secondly, interbank rates are lower than central bank lending rates, thereby also reducing the
                                           incentive of commercial banks to borrow from the central banks.
     Monica Malik
     +971 4 364 1902
     mmalik@efg-hermes.com


01             kindly refer to the
               important disclosures and
               disclaimers on back page
                                gcc economics
                                                                                                                 23 january 2008
                                flash note



                                • Increased Likelihood of Currency Reform: The aggressive rate cuts in the US increases the probability of
                                currency reform in the GCC. We have highlighted in our research that key factors in the timing of a move
                                from the GCC will be aggressive interest rate cuts in the US and/or marked weakening in the USD. Although
                                the USD has found some support with the recent turmoil in global markets, downside risks remain.
                                Furthermore, the reduction in interest rates will reach a point where the GCC will have to move. A shift to
                                linking the GCC currencies to a basket of currencies will provide the advantage of greater monetary flexibility,
                                which a straight revaluation against the USD will not provide. We maintain our view that there is a greater
                                than 60% probability of a move away from the USD peg in 1H2008 by one or more states (the UAE and/or
                                Qatar) or the GCC as a whole. In this forecast, we have taken into account aggressive interest rate cuts in the
                                US in early 2008. As the GCC countries are currently working to move in unison, the reform is likely to be a
                                revaluation rather than a move to a currency basket.

                                • Increased Size of Revaluation: We had originally forecast that a GCC-wide revaluation would be in the
                                magnitude of 3% to 5%. However, with the surge in inflation across the region, we now believe that a
                                revaluation would more likely be around 5 to 10%. Inflation in Saudi Arabia surged to 6.5% Y-o-Y in
                                December 2007. The inflation rate is also reaching multi-year highs in Oman and Kuwait. The rise in inflation
                                also has socio-political connotations and adds to the probability of GCC currency reform.




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