Crude Economics: Saudi Interest Rates Hit 6-Year High Amid Tight Liquidity

The Saudi economy is short of cash, prompting both the public and the private sector to cut their expenditures; meanwhile, bank clients are withdrawing their deposits and taking new loans, meaning the economic outlook for the oil-reliant nation is rather gloomy.

Kristian Rouz — Saudi Arabia's benchmark interest rates made their biggest advance since October 2008 in November, reaching their highest rate since at least April 2009 as low oil prices have undercut the supply of liquidity to the nation's crude-based economy. A decline in bank deposits from individuals, businesses and the government has contributed the greatest to the liquidity squeeze, rendering the Saudi investment environment utterly unfavorable for either new projects or the expansion of existing ones. The Saudi tightening of monetary conditions is adding to global underinvestment in the energy industry, laying the groundwork for a rise in crude prices in the medium-term.

According to data provided by the Saudi Arabian Monetary Agency (SAMA), the three-month Interbank Offered Rate, which determines the interest rate on commercial borrowing, rose 0.13% in November to 1.11625%. This significant advance in traditionally stable Saudi interest rates was dictated by the dramatic 10-fold rise of the Saudi budget deficit and a lack of business confidence amid the oil slump.

About 80% of Saudi fiscal revenues come from the oil industry, and crude prices are now some 40% below the level they'd fallen to twelve months ago. Consequently, there is less free money liquidity in the economy.

Demand deposits slumped 4.7% in October, and the liquidity squeeze in the Saudi banking system continued into November as well. The decline in the amount of money kept in Saudi banks has by now dropped to its early-1990s level, according to some estimates. The Saudi government has also recently failed to provide timely financing to certain development projects, which has hit the private sector.

Riyadh could have fixed the situation by introducing monetary easing measures similar to those practiced in many advanced economies, like Japan or the Eurozone countries. However, as the nation's currency, the riyal, is pegged to the US dollar, a one-time depeg would trigger a crash devaluation with serious consequences.

In absolute numbers, demand deposits slid by $13.5 bln in October, compared to the Saudi monetary reserves of about $650 bln. Deposits in the private sector dropped $6.18 bln, while public sector deposits shrunk $7.27 bln, according to SAMA data.

The Saudi government is running a budget deficit as the nation's breakeven price for oil stands at $105/bbl for this year. In order to cover expenses, Riyadh issued at least $14.65 bln worth of debt securities, drawing the money from the Saudi banks. In 2014, the Saudi fiscal deficit stood at 2.3% of GDP, even though oil prices were above $100/bbl for at least half of that year. According to IMF projections, this year the Saudi budget deficit is expected to rise to about 20% the nation's GDP.

Meanwhile, the Saudi banks have been hit by the liquidity squeeze as well. In October, their loans-to-deposits ratio rose to 83.8% from 82.5% twelve months prior.

Although the Saudi economy hasn't been badly shaken yet by the decline in oil prices, it has by now lost its development momentum, meaning the nation's capability to expand oil production is limited. As most Saudi energy projects are bound to falter amid the mounting disinvestment, crude prices will settle at a more stable foundation.