Saudi unlikely to depeg from dollar

Two events next month could trigger more pressure on the Saudi riyal: The postpone of the planned introduction of a GCC single currency and the US Fed cut of the interest rates by another 25 basis points; however, ending the Saudi Riyal peg to the dollar is unlikely, said a leading economist at a major Saudi investment firm.

Brad Bourland, chief economist and researcher at Jadwa Investment, said that the costs of altering the peg greatly outweigh the benefits for the moment particularly as imported inflation is an insignificant part of the current inflation story in Saudi Arabia.

An economic report issued by Jadwa on Monday explained that the bulk of the pressure on the riyal is coming from the offshore market.

Banks in Dubai, Bahrain and London conducting relatively small deals at levels well above the official rate while Saudi banks, who are responsible for most riyal transactions, have modestly adjusted their rates compared to the offshore banks.

On November 23, the riyal was trading at 3.705 riyals against the dollar. This is well above its official rate of 3.75 riyals, making it reach its strongest trading level since the peg was introduced in 1986.

As Saudi companies have easy access to riyals in offshore markets, “a wide and persistent disconnect between the official rate and the market rate calls into question the credibility of the official rate,” said the report.

Regardless to the mounting pressure, it is not easy for Saudi central bank SAMA, to end the riyal strong ties to the dollar.

Bourland, who was the chief economist at the Saudi Samba financial group before joining Jadwa, said that the government would be the first loser in this case.

“Oil revenues are earned in dollars and converted into riyals for budgetary spending. A revaluation would permanently impair the riyal value of oil revenues, reducing the size of the current budget surplus and accelerating the day when the budget falls into deficit,” he added.

Another reason why the Saudi government would lose is because the value of its mostly dollar-denominated foreign assets, currently in excess of $240 billion, when converted into riyals would also be cut.

Foreign investors are also to be affected by ending the peg to the dollar. “A more expensive riyal and the introduction of exchange rate uncertainty would discourage foreign investment for sure,” he explained.

Undercutting foreign investments would be a great shift to the Saudi major policy initiatives. The Saudi Arabian General Investment Authority (SAGIA) has “10 by 10” plan to place the Kingdom in the top 10 countries in terms of investment in 10 years

Saudi Arabia was the second largest FDI target in the Middle East in 2006, experiencing a 51% growth in FDI over 2005 to $18 billion, according to the UNCTAD.

The losses will extend to reach Saudi exporters as Bourland said that they would see their products becoming more expensive overseas, making them less competitive. Importers are to be affected as well since those whose goods compete with imports, such as many food products, building materials, and furniture, would suffer as imported products become cheaper, he added.

“What lies ahead?” asked Bourland. “If the dollar strengthens in international markets, then we expect pressure on the riyal to abate. However, should the dollar continue to decline and SAMA prove unable to address the pressure on riyal mounting in the offshore markets, then SAMA might begin a series of gradual adjustments to the exchange rate itself,” answered Bourland.
 
In any case, Bourland anticipate that SAMA will not change it peg to the dollar policy, in favor of another currency or basket of currencies just like what the Kuwait did.

“Such a major departure from longstanding policy would be considered in a more deliberate fashion and not done as a result of market pressures,” said Bourland.

Bourland emphasized that the twin challenges of inflation and a strong currency are associated with robust growth and that the economic outlook remains healthy.

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