In Saudi Arabia, where the currency has been fixed at about the same rate for 28 years, even the tiniest swings in the futures market reflect concern over the peg. So the 0.2% drop that traders see by next year shows this is the most worried they’ve been about it since 2009.
For Standard Chartered and Abu Dhabi Commercial Bank, that speculation - the result of the plunge in oil, Saudi Arabia’s dominant export - will prove fleeting just like it did five years ago and 16 years ago.
While the 47% tumble in crude since mid-June is slowing the flow of dollars into the world’s largest oil exporter, the country can still tap its $745bn of foreign reserves - more than any country except for China and Japan - to defend the riyal’s 3.75-per dollar peg if needed. What’s more, economists surveyed by Bloomberg last week forecast the country’s current-account surplus will remain the world’s fourth-largest by the end of 2014 even after oil’s decline.
“We have been there before and previous episodes were arguably much more serious,” Philippe Dauba-Pantanacce, a senior economist at Standard Chartered, said in an e-mail from London on Monday. For now, the peg “is still viewed by the Gulf as having more advantages than inconveniences,” he said.
The riyal traded at 3.754 per dollar last week, after reaching 3.7546 per dollar on December 18, the weakest since February 2009. Twelve-month riyal forwards, which investors use to speculate or hedge, fell to 3.7608 per dollar last week, suggesting traders were expecting a 0.2 depreciation in a year, according to data compiled by Bloomberg. During the height of the global financial crisis, when oil sank to as low as $36 a barrel, or 40% below today’s prices, the forwards priced in a drop of about 0.7% in the riyal.
Saudi Arabia’s economy can endure temporary fluctuations in crude prices, Oil Minister Ali al-Naimi said in a statement carried by the official Saudi Press Agency last week. A spokesman for the Saudi Arabian Monetary Agency didn’t immediately respond to questions by telephone on Tuesday.
Since its introduction in the 1980s, the peg has been instrumental in shielding the economy from the volatility of oil and natural gas, which provides 90% of government revenue. A fixed exchange rate helps the central bank accumulate foreign reserves when oil prices rise and avoid squandering the windfalls that anchor investor confidence during economic downturns. It also helps cap long-term inflation by effectively linking monetary policy to that of the US.
Crude oil has lost almost half of its value since June, exacerbated by a decision last month by the Saudi Arabia-led Organisation of Petroleum Exporting Countries to maintain its collective output target. The impact on the riyal was amplified by the dollar’s surge against currencies across the world, with Bloomberg’s gauge of the US currency advancing 12% since June to a more than five-year high on December 19.
The disruption in the Saudi currency market isn’t as pronounced as it was between 2007 and 2008, when speculators swung from betting on the appreciation of the riyal to wagering on devaluation.
The riyal climbed to 3.7050 per dollar in November 2007 when oil traded close to almost $97 a barrel and the weakening US currency fuelled speculation that Gulf nations may have to drop their pegs and de-link monetary policy from the US.
As a wave of subprime mortgage defaults in the US escalated into the global financial crisis in the following months, speculators reversed course, betting the Kingdom would allow its currency to depreciate. Oil tumbled 75% in five months to about $37 a barrel in December 2008, while the dollar jumped 24%. By October 2008, the riyal fell to a record 3.7751 per dollar.
The riyal started to stabilise at about 3.75 per dollar by March 2009 after Saudi Arabia’s central bank spent $32bn of its reserves in four months, reducing them to $416bn.
Since September 2009, rising oil prices allowed the country to boost foreign reserves by 93%. Even after oil’s latest retreat, the country has enough dollar revenue to shore up its finances. The current account surplus will be equivalent to about 14% of gross domestic product this year, the most in the world after Kuwait, Qatar and Singapore, according to the median of 10 economists’ forecasts compiled by Bloomberg.
“The central bank will stand firm again,” James Reeve, an economist at Samba Financial Group in London, said in an e-mail. “Reserves are massive and the country is still running a current account surplus. For me, the peg will not be broken.”
Hedge funds and other speculators betting in the forwards market don’t need a break of the peg to make money, according to Chris Turner, the London-based head of currency strategy at ING Groep. As investors brace for devaluation, the riyal can weaken in the forwards market, allowing those betting against it to reap a profit, Turner said.
“You can make money on speculation intensifying of a riyal devaluation even though the devaluation never happens,” he said in an e-mail on December 19.
Standard & Poor’s lowered its outlook for Saudi Arabia’s AA- credit rating, the fourth-highest debt grade, to stable from positive on December 5, saying the decline in oil prices dim the nation’s growth prospects. Five-year credit default swaps rose to an 18-month high of 80 basis points on December 16, before falling to 65 basis points on December 22, according to data compiled by Bloomberg.
Saudi Arabia is one of five Gulf Co-operation Council countries that keep their exchange rate pegged to the dollar. The sixth, Kuwait, links the dinar to a basket of currencies. The UAE, the third-biggest Opec oil producer, ruled out changing its peg in November after a government advisory body called for a review, saying it has helped maintain economic stability and bolster investor confidence.
