Gulf Arab central banks have succeeded in pushing up market interest rates since June despite the limited scope for maneuver left to them by the states' currency pegs to the dollar. The region's policymakers have worked together since the spring to dampen speculation that record high inflation would force them to revalue the pegs to the globally weak dollar. The dollar link generally obliges the Gulf central banks to track the Federal Reserve's monetary policy, which has taken the US benchmark rate to just 2 percent via seven cuts in less than a year. Yet Gulf central banks have effectively tightened policy using measures such as higher bank reserve requirements, and they are taking an active role in raising interbank rates while at the same time limiting the scope for currency speculation. The 3-month Saudi Interbank Offered Rate has advanced more than 110 basis points in the last two months to 3.92 percent, while the 3-month Emirates Interbank Offered Rate is up 76 basis points to 2.66 percent. “The liquidity that poured into the region in 2007 has actually gone away now because investors are not expecting a de-peg,” said Jason Goff, head of treasury sales at Emirates NBD, the region's biggest bank by assets. “Nobody is selling dollars and buying dirhams and liquidity is now tight.” Interbank rates guide corporate borrowing costs across the Gulf, where demand for credit is soaring as the economies boom on a near six-fold rise in oil prices since 2002. In the latest example, the Central Bank of Kuwait, the only Gulf state without a peg to the dollar, this week helped drive up the 3-month interbank rate by almost 40 basis points by withdrawing its guarantee of interbank transactions - a move that also made it more expensive to bet on the dinar. “Higher interbank rates will feed into the cost of credit,” said Simon Williams, regional economist at HSBC, who said that expectations the Fed will continue to hold rates this year have supported Gulf interbank rates. Recent rate tightening has happened largely because currency speculators reversed bets that some Gulf states might follow Kuwait's lead and revalue their currencies to fight inflation. A flood of funds into Gulf currencies beginning in late 2007 left interbank markets awash with liquidity and pushed Saudi and UAE 3-month interbank rates to 4-year lows in April. This, in turn, drove down corporate borrowing costs even as inflation hit an least 20-year high of 11.1 percent in the UAE last year, and galloped to more than 10 percent in Saudi Arabia this year - a more than 30-year peak. Since April, Gulf central bankers have worked together to reverse this trend primarily by insisting they would not drop their pegs or revalue before achieving a single currency plan. In the preceding months, a spell of contradictory statements from Gulf policymakers left markets betting reform was imminent. Hoping to convince markets they are committed to their pegs, regional central banks have forced banks to keep more money in their vaults. Saudi Arabia has raised reserve requirements four times since November. The moves have made it harder for banks to meet soaring demand for credit as governments and private investors direct windfall oil revenues into infrastructure, industry and real estate. “The financing requirements for infrastructure projects are getting bigger and bigger. We haven't got the balance sheet to support that,” said Goff at Emirates NBD. Negative real interest rates are exacerbating the liquidity crunch by making retail customers reluctant to deposit money. “If you get 2 or 3 percent on your savings, you'd rather keep in the trunk or under the mattress and look for better investment opportunities,” said Malcolm D'Souza, head of treasury at National Bank of Ras Al
