Saudi Arabia May Revalue With New Fed Cut, Banks Say

Sept. 24 (Bloomberg) -- Saudi Arabia, the largest Arab economy, may come under pressure to reduce borrowing costs or revalue the riyal if the Federal Reserve cuts rates again this year, Standard Chartered Plc and EGF-Hermes Holding SAE said.

Speculation has risen that the kingdom may have to abandon a 21-year old peg to the dollar or revalue its currency after the central bank decided last week not to follow the Fed's 50 basis- point rate cut, to offset higher inflation. Saudi Arabia may also be concerned that breaking the link with the dollar will undermine plans for a regional currency union.

Saudi Arabia should ``clarify its stance'' on the riyal's peg with the dollar to avoid further speculation, Standard Chartered's Chief Middle East Economist Steve Brice said in a note to clients today. ``Without such a clarification, the pressure is likely to increase with the Fed likely to cut interest rates further before the end of the year.''

The speculation that the kingdom would drop the peg, adopted in 1986 to prevent swings in the currency, caused the riyal to strengthen against the dollar last week. The riyal, which is pegged at 3.75 per dollar, strengthened to less than 3.7362 today.

The country's central bank, the Saudi Arabian Monetary Agency, may revalue the riyal against the dollar rather than de- link it if the dollar's drop continues, Saudi-owned Asharq al- Awsat newspaper reported yesterday, citing an unidentified official ``close'' to SAMA.

Currency Union

The newspaper also said the kingdom is concerned such a move would undermine plans for a currency union with the other five members of the Gulf Cooperation Council, Kuwait, Baharian, Qatar, Oman and the United Arab Emirates. Kuwait switched to a link with a basket of currencies in March.

SAMA didn't answer calls to its office in Riyadh.

The central bank chose not to follow the Fed's Sept. 18 reduction to 4.75 percent, while those of the U.A.E. and Kuwait cut their borrowing costs. Saudi Arabia's key rate is 5.5 percent.

The U.A.E., the second-largest economy in the Persian Gulf, lowered one-week, one-month and three-month certificate of deposit rates by 15 basis points. The Central Bank of Kuwait, which lowered its main rate by 25 basis points before the Fed, then reduced it another 50 basis points after the move by the U.S. central bank.

Government bond traders, who predicted six of the last seven U.S. recessions, say the Fed will lower interest rates again before the end of the year as the U.S. economy slows.

Interest-Rate Difference

If the Fed cuts again, ``it would be difficult for SAMA to follow to the same extent, thus implying a widening of the riyal to dollar interest-rate differential,'' EFG-Hermes said.

The kingdom decided this time to leave interest rates unchanged because of the rising costs of imports and an increase in local prices of food, beverages, fuel and water, according to a report by Riyadh-based Jadwa Investment Co. published in August.

``They are clearly concerned about inflation,'' Standard Chartered's Brice said in an interview today. ``If you have strong growth and high inflation then the last thing you want to do is cut interest rates. However, if you are pegged to the dollar then your interest rates are largely determined by what is happening in the States.''