Saudi Arabia is spending cash like there was no tomorrow, but the party cannot go on forever.
According to knowledgeable Bloomberg sources, government officials in Saudi Arabia have begun capital controls, telling banks in the country to stop the sale of currency futures contracts betting against the Saudi riyal.
The biggest global oil producer has maintained a peg between riyal and the dollar for many years, but as oil revenue drops due to dramatically lower prices for crude oil, many financial professionals began to question Saudi Arabia’s ability to keep the riyal – dollar peg in place. The Saudi Arabian Monetary Agency issued the directive at a January 18 meeting, and the new capital controls impact both local banks and Saudi branches of global banks, the sources noted.
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Saudi Arabia facing “perfect storm”
More than a year of low and lower crude prices have wreaked havoc on the kingdom’s budget, and the deficit is currently projected at close to 13% of GDP in 2016.
Also of import, the country has had to rein in the welfare state, and has reduced subsidies for most Saudis. Political analysts point out that this decision may eventually lead to social unrest. The ongoing war in Yemen is another major drain on the Saudi war chest.
Let’s make it clear that Saudi Arabia is not broke, as SAMA reserves currently still top $630 billion.
It’s quite possible, however, that almost all of that cash could disappear in just a few years, depending on macroeconomics, oil prices and how much longer the kingdom stays embroiled in the very expensive Yemen. The other wild card in the game is that Iran plans to increase the supply of crude by at least a million barrels per day by this time next year, so Saudi Arabia’s budget is almost certain to remain under severe stress for the foreseeable future.
Last but not least, and potentially the biggest threat to the $630 billion SAMA reserve, are the potential costs involved in protecting the riyal – dollar peg. If Saudi Arabia is truly determined to defend its 30-year-old dollar peg for the riyal, then the reserves will be drawn down much faster.
Fall of riyal – dollar peg could be major “black swan” event: BAML
Another key question, of course, is what will happen if/when the dollar – riyal peg does fall. The research team at BAML called the breaking of the riyal peg the “number one black swan event for the global oil market in 2016”:
Crude oil prices nosedived below $30 a barrel last week, which is a key number according to the BAML analysts: “For oil, however, the most crucial point is what happens to Middle East currencies and in particular to the Saudi Riyal. In fact, Saudi Arabia’s FX reserves are still high and point to an ample buffer for now, but they have been falling at a relatively fast rate. However, should China allow for significantly faster FX depreciation than is currently priced in by markets, we believe oil prices could fall further. Naturally, the FX reserve drain on Saudi could accelerate to $18bn per month if Brent crude oil prices average $30/bbl, sharply reducing the Kingdom’s ability to retain its currency peg.”
Jones Trading notes:
Countries with currencies pegged to the dollar from Saudi Arabia to Hong Kong are coming under increasing attack by traders speculating that it’s become too expensive for policy makers to continue defending exchange rates as commodities plunge and the U.S. currency soars
Bets for a devaluation of the riyal reached their highest in about two decades in January
The Hong Kong $ is nearing 10Y lows. Staggering move for a “pegged” currency