The Saudi riyal has been at a fixed rate to the US dollar since June 1986 (SAR 3.7500 per USD). Foreign exchange earnings come predominantly from oil exports, which are deposited with the Saudi Arabian Monetary Agency (SAMA). In turn, SAMA credits the government’s account with the equivalent riyals. Therefore, SAMA is responsible for meeting the foreign exchange needs of the public and private sectors by selling dollars against riyals to the domestic banks. SAMA last intervened in the foreign exchange market in 1998. This took place in the forward market, because speculation tends to be in the forward market since banks can treat it as an off-balance-sheet item. Speculation against the riyal occurred in the 1990s at times when the oil market was weak and foreign exchange reserves were falling. More recently, in 2007/08, there was an episode of speculation in favor of the riyal due to Saudi Arabia’s strong balance of payments and fiscal position, a weaker dollar, and rising domestic inflation. SAMA handled this more recent episode by reiterating its long-standing position to uphold the exchange rate regime without actual intervention.
The fall in oil prices has strained Arabian Gulf countries’ currency policy and increased the cost of carrying a US dollar peg. Saudi Arabia is the world’s biggest oil exporter and producer, where more than 73 per cent of government revenues come from the hydrocarbon sector, according to the Institute of International Finance industry group.
Saudi Arabia is pegged to the US dollar to avoid currency fluctuation and eliminate uncertainties in international transactions. All oil contracts and most commodities contracts around the world are written and executed in dollars, therefore a fixed exchange rate is especially important for Saudi Arabia.
A fixed exchange rate provides currency stability. Investors always know what the currency is worth. That makes the country’s businesses attractive to foreign direct investors. They don’t have to protect themselves from wild swings in the currency’s value. They are hedging their currency risk. This brings about greater business and consumer confidence as they know their currency will not fluctuate against the USD. The rule-based money supply policy involved in the Linked Exchange rate system also makes the note-issuing system far more transparent. Since 1986, the fixed exchange rate intervention by SAMA has contributed to broad economic objectives such as controlling inflation rate and maintaining competitiveness.
However, a fixed-rate system limits a central bank’s ability to adjust interest rates as needed for economic growth. A fixed-rate system also prevents market adjustments when a currency becomes over or undervalued. The central bank of Saudi Arabia could not cut the interest rate high to make holding riyal less attractive. In one case, the government cut the tariffs on imported goods which had led to 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. As increasing interest rate is a contractionary monetary policy, it would harm a developing economy that’s struggling to grow and may cause economic slowdown and ultimately recession. In order to increase demand government can also borrow from abroad. But this raises a concern on. Government budget and its repayment costs burden the economy in the future. By controlling supply of domestic currency, government may decide to limit imports through trade protection measure and impose exchange controls. This leads to resource misallocation and risks of retaliation that can damage the country’s economy and political position.
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.