Saudi riyal peg pressure eases, but not gone

This year’s oil price bounce has eased pressure on the Saudi riyal’s dollar peg but volatile energy swings mean the currency remains vulnerable, especially if Riyadh fails to deliver fast on its reform plans.

The world’s top oil exporter has pegged the riyal at 3.75 to the dollar since 1986 but oil’s price collapse since mid-2014 has raised expectations the kingdom will have to de-link from the dollar or at least devalue.

A more than 70 per cent bounce in oil futures since the January trough has eased these expectations with one-year dollar/riyal forward swaps – contracts used by counterparties to lock in a future exchange rate – now standing at 340 basis points, down from a record high above 1000 bps in January.

Investors say, however, that devaluation pressures have not gone away, even though Saudi Arabia has unveiled some details of a sweeping reform package.

“The reforms won’t lay the issue of currency devaluation to rest, as the peg will again come under pressure if the oil price recovery reverses,” said George Birch Reynardson at Somerset Capital Management, who is invested in Saudi stocks.

Saudi Arabia, which derives 90 per cent of state revenues from oil, has seen its foreign currency reserves pummelled and its economic growth rates slump following the steep drop in oil prices.

Deputy Crown Prince Mohammed bin Salman says he aims to end the kingdom’s “addiction” to oil and transform it into a global investment power.

He wants to sell a stake in oil giant Saudi Aramco, boost its investment fund to one of the world’s biggest and expand the private sector’s share of the economy.

Some investors and analysts have questioned how achievable the overhaul is, and Reynardson called the target of tripling non-oil revenues by 2020 “highly ambitious”.

“They need to move relatively quickly on this but, if they do, the revenues generated will buy them time and the currency risk will be alleviated, if not totally laid to rest.”

Patrick Dennis, lead economist at Oxford Economics, said markets would need to see progress by 2020, as the country has lost a fifth of its net foreign assets held by the central bank in the past 18 months.

“Carrying on at that pace, if you get down to less than half of what it is, then the markets will be seriously concerned about it and put pressures on the currency peg.”

The main pressure point for the currency regime remains oil, says Societe Generale, which attaches a 60 per cent probability of a change to the currency regime in the next two years if oil stays under $50 per barrel.

“(We) still see devaluation as the least likely scenario,” SG told clients.

“Indeed, all the measures being taken to prepare Saudi for a post oil future raise the probability of a change to a currency regime that may involve pegging the currency to a basket, as in Kuwait, in our view.”