zaterdag 16 januari 2016

The Consequences of Saudi Arabia De-pegging The Riyal

There has been chatter that the peg between the U.S. dollar and the riyal will soon be broken. Today, one U.S. dollar equals 3.75 riyal and this has been the case for 3 decades.

The reason why Saudi Arabia wants to de-peg against the U.S. dollar is because of its rising deficit. This deficit was ignited due to lower oil prices, which hit $29/barrel last week. The following chart from Tradingeconomics shows how the current account (and budget) went into deficit this year (budget deficit is 15% of GDP). This is the first evidence to support why the riyal needs to devalue, because there is a correlation between a country's budget deficit and its real exchange rate. The higher the budget deficit, the lower the exchange rate.

This current account/budget deficit coincided with the drop in oil prices from $100/barrel to $29/barrel in 2015. Saudi Arabia needs oil prices to be in the $100/barrel range for its economy to function properly.

Since 2015, Saudi Arabia has tried to keep the peg by selling its foreign exchange reserves (see chart below from Tradingeconomics). This trend cannot keep going indefinitely, which leads me to believe that the probability of de-pegging is pretty high.

Go here to read the analysis.

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