- Saudi government’s ample FX reserves/net foreign assets (NFA) has so far provided critical support to Saudi riyal-USD peg. Oil price shock is a double whammy on Saudi NFA. With hard dollar peg in place, lower oil price means lower oil revenue – which leads to slower reserves buildup – and more fiscal spending to offset the economic downturn – which leads to drawdown in FX reserves/foreign assets. The period between 2015 and 2016 represents a perfect example where we saw a sharp increase in fiscal deficit and sharp decline in Saudi NFA.
- According to IMF Article IV October 2017, the base scenario for the next five years is oil price around $50, which leads to small Saudi current account balance (<2% GDP) and small fiscal deficit (2% GDP) and only gradual drawdown in Saudi NFA. By the end of the 5-year forecast horizon, Saudi NFA should stay comfortably above 20 months worth of import.
- The downside scenario is where the oil price would stay between $30-$40 over the next five years, which means the economic hardship, large fiscal deficit and drawdown of NFA that were experienced in 2015-2016 would continue over the next five years. Saudi NFA would probably come down to a very low level (5 months of import) around the year of 2022, threatening the sustainability of the dollar peg as well as the Saudi oil-dependent economic model.
- Therefore, simply extrapolating the 2015-2016 situation to the future is too dire an assumption. That said, only a couple years are left for Saudi to reform its economic model if oil prices stay for a long time between $30-$40.
- There may be an important twist, however. What if the Saudi monetary authority SAMA tries all its best to avoid breaking the riyal-dollar peg and – alongside some piecemeal reform – asks for assistance from the Fed and PBoC? More specifically, what if SAMA sets up some kind of bilateral agreement with the Fed (or PBoC) on USD swap (or CNY swap) program? Such scenario is not unlikely given Saudi Arabia’s geopolitical importance in Middle East and the world’s dependence on Saudi oil supply.
- In other word, even if the downside scenario happens, one needs to think twice if he wants to short the riyal and expects a devaluation of riyal.