We wanted to briefly comment on the recent spate of market research notes amid chatter that Saudi Arabia may be forced to devalue the riyal by adjusting its currency peg to the dollar due to the dramatic fall in crude oil prices and the Saudi budget deficit that has opened in its wake.
It is highly unlikely to happen any time soon.
There is, in other words, no “critical” choice to either cut oil production to help boost prices or to adjust the riyal’s rate to stem the decline in foreign reserves.
The Saudi riyal has been pegged at 3.75 riyals to the dollar since 1986, and for a good reason. The peg is the bedrock of Saudi domestic economic policy and is a long standing commitment to its private sector of absolute stability in the exchange rate, indeed, the speculation over a devaluation overlooks this fundamental cornerstone of the social compact between the Al Saud ruling family and the private business community.
Calls for a possible devaluation also overlook the reality that the Saudi economy is about as dollarized as a country can get without becoming a 51st state: almost all of its revenues are dollar denominated, and a lion’s share of its imports are dollar denominated. A devaluation could stir undesired inflationary pressures or capital outflows for little gain.
To defend the peg, the Saud central bank, the Saudi Arabian Monetary Agency, has almost unlimited dollar reserves to utilize if needed. Indeed, SAMA officials take great pride in making speculators pay for trying to push the riyal down, and they have won every one of the rare speculative battles to defend the riyal for the last 30 years.
And in terms of the Saudi budget deficit the talk of how the Saudis could exhaust their foreign reserves in five or more years assumes that oil prices will never rise, or that the Saudi finance ministry will do nothing to adjust either spending or turn to other means to cover a budget shortfall.
But the ministry has already indicated there will be a slower pace of investment spending on major infrastructure projects and it will be tightening up where it finds excesses in its social spending programs, which do of course, go a long way in buying social stability.
In addition, Saudi Arabia has what is probably one of the lowest foreign debt to GDP ratio in the world and can easily issue dollar-denominated debt in the international capital markets at extremely low rates, even with a risk premium priced in for the geopolitical risks in the Mideast. And at home, the Saudi banks are highly liquid and, along with the local investment community, are clamoring for riyal-denominated sovereign debt, which means Riyadh can issue just about whatever amounts it needs to close budget deficits for some years.