Monetary and Macroprudential

Policies in Saudi Arabia

Ahmed Al-Darwish, Naif Alghaith, Pragyan Deb, Padamja Khandelwal

Saudi Arabian Monetary Agency & International Monetary Fund

May 2014

SAMA Quarterly Workshop, Riyadh

1

Outline

The macroeconomic framework and monetary policy toolkit in Saudi Arabia

International comparison of monetary policy frameworks

Empirical analysis of the monetary policy transmission

Macroprudential policy in Saudi Arabia

International comparison of macroprudential policy frameworks

Conclusion

2

Macroframework and monetary

policy toolkit in Saudi Arabia

3

Macroeconomic policy framework in

Saudi Arabia

Monetary policy anchored by the Saudi

riyal’s peg to the U.S. dollar.

A mix of policies used to influence

economic activity and financial sector

risks

Fiscal policy

Monetary policy toolkit

Macroprudential regulations

4

SAMA’s monetary policy toolkit

Instruments

Statutory Reserve Requirements

Repo and reverse repo operations for short-term

liquidity management

Sale of SAMA paper (SAMA-bills) – increasing over time

as stock of government bonds has decreased

FX Swaps – used infrequently (e.g. during crises)

Deposits Placement – used infrequently, deposits of

government agencies placed strategically with banks

over longer horizons than regular repo transactions

SAMA – Deputy for Research and International Affairs

Rates and paper used

Policy Rate: Repo rate 2% Reverse repo rate 0.25%

Maturity: Overnight, reverse repos a passive liquidity absorption facility

SAMA-Bills: papers issued by SAMA with 80% return of SIBID

Maturity: 1, 4,13 ,26, 52 weeks

Passive amount issued

Government Development Bonds (GDB) with return from 2% to 8.5%

Maturity: 2,3,5,7, 10 years, stopped issuance in 2007

Used as collateral for repo operations

SIBOR/SIBID: the Saudi Interbank Offer and Bid rates

US Fed Funds rate

6

Peg limits SAMA’S ability to set interest

rates independently

0

2

4

6

8

3 Month SIBOR Repo Rate

Reverse Repo Rate U.S. Fed Funds Rate

3-Month Deposit Rate 13 Week Treasury Bill rate

Interest rates track U.S. rates

7

Reserve requirements

Statutory Cash Reserve Ratio (CRR)

◦ 7% of demand deposits

◦ 4 % of the time and savings deposits.

Statutory Liquidity Ratio (SLR)

◦ 20 % of the total commitments of bank

deposits to be held in the form of short-term

assets convertible to cash within a month

8

SAMA has stepped up liquidity

management operations

(100)

(50)

-

50

100

150

200

250

300Excess deposits of banks

Treasury bills held by commercial

banks

Liquidity Management by SAMA(Billions SAR)

9

However, the monetary base is volatile

-20

-10

0

10

20

30

40

-100

-50

0

50

100

150

200

Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13

T-bills and repurchase agreements

Other

NIR less Govt Deposits

Monetary Base (RHS)

Contributions to Monetary Base Growth (in percent)

10

International comparison of

monetary policy frameworks

11

Heterogeneity in monetary policy

frameworks across oil exportersCountry Monetary

policy

framework

Saudi Arabia Exchange rate

anchor

Other GCC Exchange rate

anchor

Algeria Exchange rate

anchor

Azerbaijan Other*

Brunei Exchange rate

anchor

Canada Inflation target

Chile Inflation target

Country Monetary

policy

framework

Indonesia Inflation target*

Kazakhstan Exchange rate

anchor

Malaysia Other

Mexico Inflation target

Norway Inflation target

Russia Other

South Africa Inflation target

Trinidad and

Tobago

Exchange rate

anchor

Source: IMF, Annual Report of Exchange Arrangements and Exchange Restrictions, end-April 2013.

* These countries maintain a de facto exchange rate anchor. 12

Saudi Arabia’s macroeconomic

outcomes compare well

Saudi

Arabia

GCC AvgNon-GCC

Avg

0

2

4

6

8

10

12

0.0 5.0 10.0 15.0

Average growth, 2000-13

Vo

latilit

y of gr

ow

th, 2000-1

3

Saudi

Arabia

GCC Avg

Non-GCC

Avg

0

5

10

15

20

25

0.0 5.0 10.0 15.0

Ave

rage

real

expendit

ure

gro

wth

, 2000-1

3

Average inflation, 2000-13

13

Empirical analysis of monetary

policy in Saudi Arabia

14

Monetary transmission channels

Interest rate channel policy rates impact economic activity through cost

of borrowing

Credit channel availability of bank reserves impacts supply of credit

Exchange rate channel exchange rate movements impact net external

demand

Asset price channel monetary policy impacts asset prices which

generates wealth effects

15

Overview of empirical model

Purpose—examine the interest rate and credit channels of

monetary policy transmission

Vector Error Correction Model

Model the impact of movements in interest rates and reserve

money on macroeconomic outcomes

Endogenous variables include government expenditure (G), real

non-oil GDP (Y), private sector credit (Credit), prices (cpi), and

reserve money (RM).

Exogenous variables—oil prices, U.S. GDP, U.S. CPI, and U.S. fed

funds rate.

Saudi interest rate proxied by fed funds rate

16

Results – Long run relationship (1/3)

Long run relationship between endogenous variables is estimated as:G + 8.42*Y - 3.24*Credit + 10.36*CPI - 6.54*RM - 82.49 =et

(3.0) (-3.2) (4.1) (-4.6)

Interpretation: An increase in G or Y is associated with an increase in Credit and RM. Similarly, an increase in Credit or RM may be associated with an increase in G, Y, and the CPI.

Deviations from long-run equilibrium are corrected primarily through adjustments in Y and CPI.

17

Results – Impulse responses (2/3)

Figure . Saudi Arabia: Impulse Responses from a Cholesky 1 s.d. shock

-0.04

-0.03

-0.02

-0.01

0.00

0.01

0.02

0.03

0.04

0.05

1 2 3 4 5 6 7 8 9 10

Response of Credit fromshock to Monetary base

-0.01

0.01

0.02

0.03

1 2 3 4 5 6 7 8 9 10

Response of Non-oil Output from shock to Credit

18

Results – Summary (3/3)

An increase in the U.S. fed funds rate has a significant negative impact on prices but not output – suggesting that normalization of US monetary policy will have limited impact in SA

Credit has a positive and statistically significant impact on non-oil output after 7 quarters – suggesting that credit channel is working

Weak evidence of economic impact from shocks to RM – suggesting scope to develop this further

Increase in oil price increases G with a six month lag

Inflation in partner countries increases Saudi Inflation

US GDP increases Y with a 3 month lag

19

Comparisons and caveats

Results are qualitatively similar to Espinosa and

Prasad (2012) and Cevik and Teksoz (2012)

Caveat:

◦ Useful to check results using a model of

monetary transmission through bank lending

(using lending and deposit rates data)

20

Macroprudential policy toolkit in

Saudi Arabia

21

Macroprudential policy can be used

countercyclically

Fiscal policy main countercyclical tool

But not always flexible enough to prevent credit booms

Expenditure rigidities

Lags in implementation

Volatilities in oil revenues

Countercyclical macroprudential policy can be used to influence economic activity and financial sector risk

22

Saudi macroprudential toolkit

Capital Tools Leverage Ratio

Provisions

Liquidity Tools Loan to Deposit Ratio

Liquidity Requirements

Sectoral Tools Concentration Limit

Loan to Value Ratio

Debt to Income Ratio

Exposure Tools

SAMA has used several macroprudential

instruments (MPI) in the past…

23

Countercyclical MPIs in Saudi Arabia

MPIs have generally not been used in a countercyclical way in Saudi Arabia

SAMA encourages banks to provision in a countercyclical way, but

SAMAs countercyclical provisions are part of the supervisory process and done on a bilateral basis with individual banks

Based on microprudential concerns such as operating performance, composition of assets and riskiness of loan portfolio.

The changes in provisions are not based on macroeconomic developments

24

Despite countercyclical provisioning, credit

has been volatile

Sources: Country authorities; and IMF staff calculations.

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2013 2014

Credit Growth Oil Price Growth (RHS)

25

International comparison of

macroprudential policy

frameworks

26

Comparison of toolkit

Capital Tools Leverage Ratio

Provisions

Liquidity Tools Loan to Deposit Ratio

Liquidity Requirements

Asset Maintenance Ratio

Sectoral Tools Concentration Limit

Loan to Value Ratio

Debt to Income Ratio

Sectoral Capital Buffers

Limits on Domestic Currency Loans

Exposure Tools Real Estate

Interbank

FX and Currency Limits

SAMA toolkit is comparable to other

commodity exporters.

27

Countercyclical macroprudential policy is

increasingly the norm

Country Capital Liquidity Sectoral Exposure

Saudi Arabia

Kuwait

Algeria

Azerbaijan

Brunei

Canada

Chile

Indonesia

Kazakhstan

Malaysia

Mexico

Norway

28

EffectivenessCross-country evidence

Sources: Lim et al (2011), International Financial Statistics.29

EffectivenessCanadian Experience

Sources: Krznar and Morsink (2014), Bank of Canada.

0%

2%

4%

6%

8%

10%

12%

14%2006 -

Jan

2006 -

Ap

r

2006 -

Ju

l

2006 -

Oct

2007 -

Jan

2007 -

Ap

r

2007 -

Ju

l

2007 -

Oct

2008 -

Jan

2008 -

Ap

r

2008 -

Ju

l

2008 -

Oct

2009 -

Jan

2009 -

Ap

r

2009 -

Ju

l

2009 -

Oct

2010 -

Jan

2010 -

Ap

r

2010 -

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l

2010 -

Oct

2011 -

Jan

2011 -

Ap

r

2011 -

Ju

l

2011 -

Oct

2012 -

Jan

2012 -

Ap

r

2012 -

Ju

l

2012 -

Oct

2013 -

Jan

2013 -

Ap

r

2013 -

Ju

l

2013 -

Oct

Residential mortgage (average at month end)

Indicates mortgage rule tightening

(y/y growth)

30

Early Warning System (EWS)

EWS prerequisite for using MPIs countercyclically.

Indicators to identify systemic risks such as macroeconomic imbalances and exuberant credit growth

inter-linkages between financial and real sectors

fragility in the structure of the financial system

can be used to determine timing for activation or

deactivation of MPIs (CGFS, 2012) and bring clarity

and credibility to macroprudential policy

Indicators can be used in a ‘Rule Based’ fashion to time use of MPIs

(e.g. Swiss guided discretion approach for CCB)

‘Discretionary’ fashion to guide macroprudential policy

(e.g. UK core indicators monitored by the FPC)

31

FSR and Dashboard

Country First FSR

Bahrain 2007

Kuwait 2013

Oman 2013

Qatar 2010

United Arab

Emirates2013

Country First FSR

Azerbaijan 2010

Canada 2002

Chile 2004

Indonesia 2003

Kazakhstan 2006

Malaysia 2006

Mexico 2006

Norway 1997

Russia 2012

South Africa 2004

SAMA lags GCC & commodity exporters in terms of

FSR, but is planning to publish one soon.

SAMA has developed “internal” macroprudential

dashboard.

32

Formal framework essential to ensure

effectiveness

Strong accountability with clear objectives - Establish responsibility for macroprudential policy

-Coordination and willingness to act

Access to information for effective EWS- Indicators (possibly with thresholds) can counter

biases for inaction

Powers to act in the face of evolving risk-Can be ‘hard’ (direct), ‘semi-hard’ (comply or

explain) or ‘soft’ (recommendation) depending on tools and country specific factors

Communication to create public awareness of risk- Signaling channel of the transmission mechanism

33

International experience with

macroprudential frameworks

Several countries moving towards formal framework

Three models have emerged Central Bank with explicit mandate and powers

(Czech Republic)

Committee within central bank (UK Financial Policy Committee)

Committee outside central bank (Australia, France, USA)

Saudi Arabia considering formal framework – this should be in SAMA

34

Conclusion

35

Key takeawaysShort run issues

There is limited evidence of an adverse impact on GDP from

normalization of US monetary policy

Monetary policy framework

Saudi Arabia’s exchange rate peg has served it well

Although liquidity management toolkit is being developed,

monetary base is volatile

There is scope to strengthen liquidity management

operations as a channel for monetary policy transmission

A liquidity forecasting framework and review of the

instruments to improve effectiveness may help

36

Key takeaways

Macroprudential policies

Countercyclical macroprudential policy can help curtail

credit booms and financial sector risk

SAMA has an adequate toolkit, but tools have not been

used countercyclically

Macroprudential framework needs strengthening to

ensure effectiveness in countercyclical role

37

Questions?

38