Question

Find the currency of your home country( Saudi Riyal) and describe its value relative to the USD. Is it under or over-valued compared to the USD? What problems or benefits do you think this relationship might cause for your country? Why?

•What problems or benefits do you think this relationship might cause for the US?

•Governments often intervene (manipulate) in foreign exchange markets to give their currency a more favorable rate. Do some research on the web to see what intervention has occurred or has been discussed lately regarding your country’s currency.

Answer 1

Currency exchange rates make up a very important part of a nation's economy. The exchange rate is the value of the currency compared to another one. The value of some currencies are free-floating. This means they fluctuate based on supply and demand in the market, while others are fixed. This means they are pegged to another currency. In this article, we discuss exchange rates that are pegged to the U.S. dollar as well as some of the benefits of taking on this strategy.

• There are two types of currency exchange rates - floating and fixed.
• The U.S. dollar and other major currencies are floating currencies - their values change according to how the currency trades on forex markets.
• Fixed currencies derive value by being fixed or pegged to another currency.

Pegging is a way for countries to do that. When a currency is pegged, or fixed, it is tied to another country's currency. Countries choose to peg their currency to safeguard the competitiveness of their exported goods and services. A weaker currency is good for exports and tourists, as everything becomes cheaper to purchase. The wider the fluctuations in currencies, the more detrimental it can be to international trade. Many countries, though, chose to maintain a fixed policy and today there are still a significant number of currencies pegged to the U.S. dollar. In the Middle East, many countries including Jordan, Oman, Qatar, Saudi Arabia, and the United Arab Emirates peg to the U.S. dollar for stability—the oil-rich nations need the United States as a major trading partner for oil.

Oil economies are different, and their management does pose some unique challenges. Since the government of oil exporters often controls the country's oil export receipts rather directly, the government budget plays a bigger role in the creation of a national savings surplus than in a country like China, where export receipts are private and central bank intervention is absolutely crucial. Building up an external buffer of hard currency assets in good times is one way to help protect an economy from the fluctuations in oil markets.  But a good idea can still be taken too far. If, as the market now expects, oil prices will remain high for some time, simple arithmetic suggests that the oil exporters will have to play a role in global adjustment.  

The Kingdom of Saudi Arabia (KSA)’s economy is heavily dependent on oil (the second-largest reserves globally), as income from oil exports account for over 90% of the revenue and forms approximately 50% of its GDP. Government expenditure/investments are driven by income from oil exports. The Saudi stock market index, known as the Tadawul , is the largest stock market in the Middle East. Saudi Arabia is one of the fastest growing countries in the world. Per capita income is expected to rise from ~USD$15,000 in 2006 to >$33,000 in 2020, due in part, to the establishment of six new “economic cities.

SAR Is Pegged To:

• United States Dollar = 3.75 SR

Saudi Arabia has pegged its currency Saudi Riyal (SAR) to the US dollar (USD), as *:

• Saudi Arabia is a resource-based economy; its foreign exchange receipts and payments are predominantly in US dollars.

• A stable USD/SAR exchange rate is critical to encourage investments in Saudi Arabia. This would diversify its economy and help plan state budgets.

Since the most sought-after commodity in the world—oil—is priced in U.S. dollars, the petrodollar helped elevated the greenback as the world's dominant currency. With its high status, the U.S. dollar enjoys what some have asserted to be the privilege of perpetually financing its current account deficit by issuing dollar-denominated assets at very low rates of interest as well as becoming a global economic hegemony. However, the privileges associated with being able to run persistent current account deficits come at a price. As the reserve currency, the United States is obligated to run these deficits to fulfill reserve requirements in an ever-expanding global economy. If the United States were to stop running these deficits, the resulting shortage of liquidity could pull the world into an economic slump. However, if the persistent deficits continue indefinitely, eventually, foreign countries will begin to doubt the value of the dollar, and the greenback may lose its role as the reserve currency. This is known as the Triffin Dilemma.

The petrodollar system also creates surpluses of U.S. dollar reserves for oil-producing countries, which need to be "recycled." These surplus dollars are spent on domestic consumption, lent abroad to meet the balance of payments of developing nations, or invested in U.S. dollar-denominated assets. This last point is the most beneficial for the U.S. dollar because petrodollars make their way back to the United States. These recycled dollars are used to purchase U.S. securities (such as Treasury bills), which creates liquidity in the financial markets, keeps interest rates low, and promotes non-inflationary growth. Moreover, the OPEC states can avoid currency risks of conversion and invest in secure U.S investments.

Recently there have been concerns of a shift away from petrodollars to other currencies. In fact, Venezuela said in 2018 that it would begin selling its oil in the yuan, euro, and other currencies. Then, in 2019, Saudi Arabia threatened to abandon petrodollars if the U.S. moved forward with a bill—called NOPEC—that would allow the U.S. Justice Department to pursue antitrust action against OPEC for manipulating oil prices. In short, the changing landscape of the global energy market could result in a de-facto end to the U.S.-Saudi petrodollar agreement.

Meanwhile, the U.S. is becoming a major exporter of energy for the first time since the 1960s. This, along with a strong domestic energy sector that focuses on exports, could help a smooth transition away from the petrodollar as energy exports replace the capital inflows from Saudi purchases of U.S. assets and uphold global demand for the U.S. dollar. An added advantage for the United States is that it will ensure domestic energy security, which was the main reason for the petrodollar agreement in the first place.

Nevertheless, while it will not happen overnight, a drying up of recycled petrodollars could drain some liquidity from American capital markets, which will increase the borrowing costs (due to higher interest rates) for governments, companies, and consumers as sources of money become scarce.

After the 1970s, the world switched from a gold standard and petrodollars emerged. These extra-circulated dollars helped elevate the U.S. dollar to the world reserve currency. The petrodollar system also facilitates petrodollar recycling, which creates liquidity and demand for assets in the financial markets. However, the cycle could reach an end if other countries abandon petrodollars and begin accepting other currencies for oil sales.

FX intervention is at the discretion of SAMA, acting within the confines of the exchange rate regime. Intervention is occasional and aimed at preserving exchange rate and financial stability. Intervention is not used to accumulate foreign exchange reserves or to strategically change the portfolio decisions of domestic and external operators (e.g. SAMA has not to date signalled any indication that it is considering adjusting the exchange rate regime to attract foreign capital).

SAMA responds both passively and actively. Passively, SAMA keeps providing spot dollars to the domestic banks to meet the commercial and financial demand of the private sector so that speculators find it difficult to distort the spot riyal rate. Actively, SAMA’s policy has been to intervene on a discretionary basis in the forward market, given speculators’ preference to target the forward market. SAMA’s approach of gathering relevant information from the domestic banks (i.e. learning about the size of open positions, trading volumes and the origins of transactions) has proven to be helpful and successful without a need for large scale intervention. Supportive actions have included liquidity injection through deposit placements with the domestic banks, and use of foreign exchange swaps in order to achieve the maximum possible effect on lowering swap points (i.e. buying USD/SAR spot and selling forward). When the speculation is in favour of the riyal, a wider range of tactics is available. In theory, riyal interest rates could be cut to make holding riyals less attractive and reduce the positive carry for speculators. But this would have consequences for the economy as a whole. Prudential steps have proved effective. In 2007/08, SAMA raised the minimum reserve requirements for domestic banks. This curbed excessive money supply growth, drained liquidity from the system and made it more difficult for speculators to acquire the riyals they wanted. During 2007 and 2008, the reserve requirement was raised in aggregate from 7% to 13% for demand deposits and from 2% to 4% for time and savings deposits. At the same time, the government took action to cut import tariffs and subsidise basic imported foodstuffs, thus dampening media comment that rising food prices might force a revaluation of the currency. Consumer price inflation peaked in July 2008 at 11.1%, and SAMA gradually brought the reserve requirement down by November 2008 to 7% for demand deposits, leaving it unchanged at 4% for time and savings deposits.

In conclusion, Saudi Arabia is necessary to have pegged currency with the USD as it is an economy very much relying on export of oil. Fluctuation in exchange rate may bring negative impact on its balance of trade. Although there are drawbacks such as loss of power of central bank implementing monetary policy, benefits exceeded disadvantages in history view point.