Qatar's central bank said on Monday it needs to guard against a large interest rate differential with advanced economies, which could spur heavy capital inflows, and must ensure sustained bank lending to support growth of the Gulf Arab economy.

The central bank, in its 2009 financial stability review, released on Monday, said liquidity management and ensuring orderly financial market conditions were of "paramount importance" given the return of capital inflows to the Gulf.

"With the Qatari riyal pegged to the dollar, a large interest rate differential between Qatar and advanced economies may lead to heavy inflows of capital with its attendant challenges for liquidity management and financial stability," it said.

"However, in light of recent experience, it has been possible to effectively meet these challenges by adopting a flexible approach in the conduct of monetary policy and complementing it with measures that strengthened financial stability," the central bank said.

Qatar cut its overnight deposit rate by 50 basis points to 1.5 percent in August, the first reduction in more than two years, to support the non-oil economy and curb capital inflows.

"Because of interest rate differentials, Qatar could be receiving money from outside the country. They could be cautioning the banking system that this is of concern," said John Sfakianakis, chief economist at Banque Saudi Fransi.

Private sector deposits in Qatari banks climbed to $48.68 billion in May, their highest level since at least 2005, as the global economy has improved and commercial banks' deposit rates stayed relatively high.

The dollar peg limits the central bank's flexibility to move too far from the U.S. benchmark rate, as that could put its currency link under pressure.

The U.S. Federal Reserve is expected to keep rates in a range of zero to 0.25 per cent through mid-2011.

CREDIT GROWTH

The Qatar central bank also said the banking system was sound and banks had comfortable provisions against non-performing loans.

The Qatari government spent about 6.5 per cent of GDP last year on capital injections and other measures to maintain stability in the sector.

The world's top liquefied natural gas exporter is set to see double-digit growth this year, well ahead of the rest of the Gulf, due to expansion of its gas facilities and high government spending, although private sector credit growth remains modest.

In its financial stability review, the central bank said it saw rising evidence that Qatar, an OPEC member, was recovering rapidly from last year's slowdown.

"In order to support the growth momentum, monetary policy would have to ensure the sustained flow of credit to the economy, particularly the non-hydrocarbon sector," the central bank said.

Qatar's real gross domestic product is expected to grow by 15.5 per cent this year, up from 8.7 per cent in 2009 but below 25.4 per cent in 2008, a Reuters poll shows. Other Gulf oil states expect low single-digit growth this year.

Bank lending to the private sector, which has slowed sharply after soaring 40 per cent in January 2009, rose 3.1 per cent in May from a year earlier, central bank data shows.