Saudi Arabia's (SA) economy is caught between a rock and a very hard place.
There are two immediate issues:
(i) SA needs oil price of 70+ to break-even fiscally, i.e. to cover all of its government expenditure.
(ii) SA has an exchange rate pegged to the US $
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There are two immediate issues:
(i) SA needs oil price of 70+ to break-even fiscally, i.e. to cover all of its government expenditure.
(ii) SA has an exchange rate pegged to the US $
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With oil price in the 20s, SA is running a huge deficit and burning through its reserves.
This is not sustainable unless oil price rises sharply soon and then stays there.
But that's unlikely, given a looming global recession and a world moving away from combustion engine.
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This is not sustainable unless oil price rises sharply soon and then stays there.
But that's unlikely, given a looming global recession and a world moving away from combustion engine.
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So what gives?
If SA had a flexible exchange rate, it could devalue Riyal. This would help cut down its imports and make it more attractive for locals and outsiders to invest in the non-oil sector. SA could also have run an independent monetary policy.
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If SA had a flexible exchange rate, it could devalue Riyal. This would help cut down its imports and make it more attractive for locals and outsiders to invest in the non-oil sector. SA could also have run an independent monetary policy.
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But SA chose an unwise exchange rate regime
How much over-valued is the Saudi Riyal in the face of declining oil prices - which started in 2014?
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How much over-valued is the Saudi Riyal in the face of declining oil prices - which started in 2014?
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One way is to compare Riyal with Russian Ruble, since Russia is also an oil-dependent country *but* with a flexible ER.
We can see that while Ruble has depreciated over 50% relative to US$, Riyal has not.
This suggests that the Riyal may be overvalued 2 times.
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We can see that while Ruble has depreciated over 50% relative to US$, Riyal has not.
This suggests that the Riyal may be overvalued 2 times.
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The truth is probably worse given low labor productivity for SA.
But the deepest trouble is that any break from the peg at this stage will create all kinds of massive balance sheet dislocations - a financial crisis of sorts.
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But the deepest trouble is that any break from the peg at this stage will create all kinds of massive balance sheet dislocations - a financial crisis of sorts.
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To recap, 3 major costs of fixed ER with falling oil:
1) prevents SA from diversifying out of oil due to an over-valued ER.
2) forces SA to burn through reserves to finance a large deficit
3) inevitable break from peg will not be pretty
1) prevents SA from diversifying out of oil due to an over-valued ER.
2) forces SA to burn through reserves to finance a large deficit
3) inevitable break from peg will not be pretty
