The centrality of the Saudi fixed peg currency regime
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From time to time, the Saudi fixed peg has come under speculative pressure for the riyal to be loosened from its US dollar anchor. This has occurred during periods of low oil price volatility and sharp drawdowns of the Kingdom’s foreign exchange reserves, such as during the 2008-2009 global financial crisis, and the more recent 2014-2015-oil price collapse. Even more recently, though it was more muted, it also happened due to the sharp drop in oil prices following concerns over the omicron coronavirus variant.
Are the arguments to de-peg justified, and why has Saudi Arabia continued to justify its fixed peg currency regime? These are not academic questions, but have a significant impact on both domestic business and foreign investors operating in the Kingdom.
Since the beginning of the post-OPEC oil price hikes of 1973, Saudi Arabia’s monetary and exchange rate policy has been dominated by a de facto Saudi riyal peg, either to the International Monetary Fund’s Special Drawing Right or the US dollar. Prior to mid-1981, the riyal was loosely pegged with the SDR basket of currencies, but in a major policy decision, from 1986 to the present, the riyal has been tightly pegged at SR3.75 to the dollar. What, then, are the pros and cons of a fixed exchange rate that makes Saudi Arabia so attached to it?
The advantages intuitively seem extensive, whereby a fixed exchange rate maintains investor confidence in the currency, encouraging domestic savings and investments and discouraging capital outflows, and reduces inflationary pressures associated with devaluation, witnessed by some Arab economies and Iran today. While Saudi Arabia’s current regime is a fixed conventional peg, the Kingdom’s central bank is not statutorily committed to maintain the peg at that rate forever, and the peg can be adjusted either up or down when misalignment or intensive speculative pressure becomes a problem.
SAMA can, and has, defended the peg either through direct intervention in the spot and forward markets, or indirectly through monetary policy and domestic interest rates, such as setting a premium on Saudi riyal interest rates over comparable US dollar rates. Above all, what Saudi monetary policymakers want to achieve by a fixed rate regime is stability, given that the peg is a credible, clear and easy to understand nominal anchor for businessmen and foreign investors.
Various SAMA governors have been vocal on record that the peg is more of a benefit than a disadvantage. As such, SAMA’s policy creditability and the preservation of substantial reserves of liquid foreign currency assets become key parameters to maintaining the peg. This becomes a key disadvantage, which includes a requirement for a high level of international reserves and low ability to absorb shocks, which are instead passed on to the economy.
A fall in Saudi international reserves over the period 2015-2020 from SR2.311 trillion in 2015 to SR1.7 trillion in 2020, has been triggered by a combination of sharply reduced oil prices, sluggish global energy demand since the COVID-19 pandemic hit, and budget deficit drawdowns by the Kingdom. This has led to a more pessimistic outlook that more reserves could be exhausted, but such pessimism has not taken into account government fiscal reforms, non-oil revenue increase and the tremendous borrowing capacity of the Saudi government, and its proven ability to borrow from both domestic and international sources.
The other key disadvantages of a fixed peg regime is that this does not allow the implementation of an independent monetary policy whereby the pegged currency country has to follow the monetary policy changes of the foreign currency, which might not be appropriate for its own domestic economic condition. Another argument is that fixed exchange rates cannot be adjusted for external shocks or trade imbalances, whereby a floating exchange rate allows a country to adjust with lower export prices and higher import prices helping to regain external balance of payment equilibrium, and that a fixed peg is also a fixed target for speculation.
On balance, Saudi Arabia has a more than comfortable level of foreign reserves to defend the fixed peg, underpinned by the Vision 2030 objective to gradually phase out the Kingdom’s dependence on oil and rely more on other sources of income, as positive recent quarterly budget figures illustrate. All this ensures that there is little short or medium term likelihood that SAMA will change the current fixed dollar peg rate policy, as there are also political considerations given a close Saudi-US economic and geopolitical relationship.
SAMA governors and other government officials like to remind us that there is no such thing as a “painless devaluation” of the Saudi riyal as a way to balance Saudi budget deficits by boosting government oil revenues, as a devaluation through a floating exchange rate would raise import costs to both the general public, businesses and the government. SAMA officials also point out that the central bank has been able to maintain a stable exchange rate, even during different economic cycles and market conditions, and that short-lived volatility in the spot and forward exchange markets is overcome by the effectiveness of the current fixed peg framework.
Given the hoped for FDI and joint venture plans for Saudi Vision 2030 implementation, it is imperative that the Saudi regulators continue to signal to foreign investors their commitment to the fixed peg as a central plank of monetary policy.
• Dr. Mohamed Ramady is a former senior banker and professor of finance and economics, King Fahd University of Petroleum and Minerals, Dhahran.
