A man holds a 50 riyal ($13.3) note.ALI JAREKJI/Reuters
As commodity-linked currencies around the world falter in the face of slumping resource prices and sliding economies, speculators are betting heavily that the last major holdout – the Saudi riyal – will inevitably be joining them. But they may be in for a long and ultimately futile wait.
The riyal plunged to a record low in the forward market Tuesday, signalling a conviction that the Saudis will not be willing or able to maintain the fixed peg to the U.S. dollar much longer as oil revenues shrink and their fiscal woes deepen.
One-year U.S. dollar-riyal forward contracts soared above 1,000 basis points, well beyond the previous high of 850 points in 1999, which means gamblers are looking for a sharp devaluation against the ever stronger U.S. currency. The riyal is currently fixed at a rate of 3.75 to the greenback, leaving plenty of room to depreciate if it's ever cut loose from its moorings.
But currency experts say it's unwise to bet against the Saudis' determination and capacity to prop up their currency, as market veterans can attest from previous painful experience.
On Monday, the Saudi Arabian Monetary Agency reaffirmed its commitment to the three-decade-long dollar peg "backed up by the full range of monetary policy instruments, including its foreign-exchange reserves."
And when it comes to fending off speculative attacks on the riyal, analysts suggest we should take the Saudis at their word.
"Stay away from the Saudi riyal peg trade," was Deutsche Bank's blunt advice in its latest quarterly assessment. "The Saudis have several as-yet untapped sources of dollar financing. One is to simply issue dollar debt. Debt was far higher and reserves far lower during successful defences in 1998-2003."
After shrinking by nearly $100-billion (U.S.) in the previous fiscal year, Saudi reserves still stand at $635-billion, about 95 per cent of GDP.
Record outflows and deteriorating trade conditions could further reduce that ammunition to $510-billion by the end of next year, Deutsche Bank emerging markets currency strategist Daniel Brehon notes in the report. "Even still, they will be far larger as a share of the economy than China (30 per cent) and equal to Switzerland."
Saudi Arabia has enough net foreign assets in the vault "to tolerate at least one more year of a massive fiscal deficit," Mehran Nakhjavani, a global strategist with MRB Partners in Montreal, said in a new evaluation of Saudi prospects.
That deficit ballooned to a record 15 per cent of GDP last year and will widen to an astonishing 20 per cent this year, Capital Economics said in a report last month. And if the government fails to impose promised austerity measures, including a sharp reduction in costly energy, housing, water and other subsidies, the reserves might not last five years, the International Monetary Fund warns.
Still, Riyadh is "just beginning to ramp up a domestic borrowing program and is considering privatizations, both of which will limit the drawdown of its sovereign wealth funds and extend its ability to run fiscal deficits into next year," Mr. Nakhjavani said.
The last thing Riyadh wants is to follow smaller oil players, including Nigeria, Kazakhstan, Angola and Azerbaijan, that have already abandoned or loosened their currencies' link to the dollar, sending their value off a cliff. All have taken far bigger hits in foreign-exchange markets than some resource peddlers with floating-rate currencies such as Canada, Norway and Colombia.
The Saudis worry about the risks to their banking system of a free-falling currency. But more than that, they fear widespread social unrest would be triggered by soaring import costs. To contain such risks, the royals would have to shore up the banks, pour even more money into subsidies and bolster an already huge military and policing budget. So any benefit from a depreciating currency would be quickly eliminated.
"Our take is that a riyal devaluation is highly unlikely for as long as a credible central government exists in Riyadh," Mr. Nakhjavani says.