SAUDI CREDIT MARKET TIGHTENS, MAKING FINANCING

UNCLAS SECTION 01 OF 02 RIYADH 001353 SENSITIVE SIPDIS DEPT FOR NEA/ARP AND FOR EEB E.O. 12958: N/A TAGS: EFIN ECON EINV EPET AFIN SA SUBJECT: SAUDI CREDIT MARKET TIGHTENS, MAKING FINANCING SCARCE REF: RIYADH 1258 ¶1. (SBU) Summary: Saudi Arabia's credit market continues to tighten, driving up the cost of borrowing, thanks in part to high demand for Saudi riyals from regional firms driven out of the tight international credit market and from Saudi banks looking to mitigate the effects of the U.S. subprime mortgage crisis. Meanwhile, the supply of riyals has been contracting as the Saudi Arabian Monetary Agency seeks to contain near-record inflation. Should these trends continue, the cost of financing corporate projects is likely to increase substantially. End summary. -------------- High demand for Riyals -------------- ¶2. (SBU) Despite a low central bank interest rate reflecting the peg of the Saudi Arabian Monetary Agency's (SAMA) benchmark rates to those of the U.S. Federal Reserve, the cost of borrowing in Saudi Arabia has jumped substantially in the past few months due to high demand for riyals. This increased demand has been fuelled in part by the widely-reported, dramatic increase in spending on infrastructure, energy, and industrial projects made possible by surging oil revenue. So far in 2008, corporate lending has expanded by 20 percent, with 1.9 trillion riyals ($507 billion) in new projects announced. The three-month Saudi interbank offer rate is now at 4.1 percent, close to twice where it was in May, and 131 basis points higher than the U.S. three-month rate. ¶3. (SBU) Chief Economist of the Saudi firm Jadwa Investment, Brad Bourland, told econoff in an August 23 courtesy call that increased corporate demand for credit in Saudi Arabia has been augmented over the past few months by Saudi banks' own increased demand for credit as they react to the subprime mortgage crisis in the United States. Rather than accept significant mark-downs in the value of their overseas investments, Bourland said, Saudi banks have been seeking additional cash to purchase the assets underlying those investments. ¶4. (SBU) Foreign demand for riyals, particularly from currency speculators, has also been high. Banks and private individuals had been betting the Saudi government would be forced to de-peg the riyal from the dollar in response to SAMA's inability to mitigate domestic inflation which has risen to over 11 percent annually, a 30-year high. However, demand from currency traders has eased in recent weeks as the riyal and dollar have appreciated against the euro. Some Saudis who were on the fence about how their country's exchange rate should be set now are patting themselves on the back for not vocally supporting the abandonment of the country's long-time dollar peg, while domestic critics of the peg have grown noticeably more quiet as pressure on the exchange rate appears to have subsided. -------------- Supply of Riyals also limited -------------- ¶5. (SBU) Another factor increasing borrowing costs is that growing demand for credit is colliding with SAMA's efforts to limit inflation by restricting the available money supply. SAMA has increased banks' reserve requirements four times since November 2007, the first such increases since 1980. An August 21 article in Arab News described how deposits from private individuals have also declined as, with inflation over 11 percent (see reftel),Saudi residents have little incentive to deposit their earnings in accounts receiving 4 percent interest. Many Saudis also have less to save given the country's rapidly increasing food and rent prices. -------------- Corporate projects costs to increase -------------- ¶6. (SBU) Comment: Most of the factors leading to the current tight credit market in Saudi Arabia are unlikely to ease in the near future. Ironically, markets are continuing to tighten even as the country as a whole is accumulating great wealth from oil prices that, despite recent declines, remain significantly above $100 per barrel. Embassy banking sector contacts say inflation is likely to level off in the next few months but remain relatively high for the next three to four years. Should the local credit market remain this tight, RIYADH 00001353 002 OF 002 project finance costs are likely to increase, possibly pricing smaller firms out of the credit market. This would undercut the Saudi government's attempts to encourage the growth and economic diversification of the country's private sector, which is essential to help create jobs for its large youth population. End comment. RUNDELL