Fawaz H. Al-Fawaz
Published — Saturday 15 December 2012
Last update 15 December 2012 5:38 pm
The central banks in the US, European Union, Japan took policy steps over the last few months to continue their expansionist monetary policies. Australia also announced similar measures recently.
Perhaps the most important is the US Federal Reserve’s third round of program to purchase mortgage-backed securities well into 2014. This wave impelled the Brazilian finance minister to characterize the American policy as a “currency war.”
The US dollar's dominant position as the reserved currency for developing countries and the key role it plays in pricing commodities including oil is the background for this article.
Every now and then we hear or read about Saudi observers demanding a change or adjustment to the currency peg.
The plethora of interdependent set of relationships forces us to revisit the subject of the Saudi riyal-dollar peg. Let me say at the outset that I find the Saudi policy palatable and still serves the national economy (Al-Eqtisadiyah No. 6287 dated Dec. 28, 2010).
The conventional analyses tell us that the increased supply of dollars will likely pressure some free floating currencies, making exports from those countries more expensive; yet since most other countries of significance are either involved in monetary easing and or fiscal expansions, the net result is roughly to keep the same currency alignment as it prevailed during the pre-2008 crisis.
Hence, we have not seen any significant movement in currencies against the dollar over the last four years or so aside from the Chinese renminbi's revaluation of around 23 percent against the dollar over the same timeframe.
Saudi Arabia depends on oil revenues to finance its fiscal needs and economic wellbeing. Hence the financial considerations are more important than the economic imperatives such as the real economic growth and productivity.
Hence, the monetary policy machinations are going to be less important until the economics becomes more important than the financial aspects. This is not going to take place in the medium term; As Keynes said, ‘In the long run, we are all dead.’
Economic management in the Kingdom is still centered on subsidies and infrastructure expansion in material and human capital and this is a function of government expenditures rather than indigenous economic forces.
The key factors that govern the relationship between the dollar and riyal are still relevant. First, oil is still priced in dollar, which makes practically all Saudi exports priced in dollars and a good measure of imports as well.
Second, the correlation between commodity prices and dollar is positive in the long-term in spite of what appears to be a negative correlation in the short-term.
Consequently, the increase in oil revenues is higher than the expenditure for imports, allowing Saudi Arabia to maintain a positive merchandize trade balance.
However, what might be true for the economy as a whole maybe not true for all segments of society.
Inflation is much more pronounced for the lower strata, as a larger share of their incomes is spent on necessities that are dependent on rising international commodity prices.
The way to deal with such anomalies is to assist Saudi nationals in need directly rather than an across-the-board subsidy system. The recalibration of the costly subsidies system is overdue as it distorts economic activities and is not sustainable in the medium-term.
Third, developing countries such as Brazil, Turkey, India and China, where currencies are more flexible, find that the US currency interest rates and the risk of declining dollar value make their dollar-based investments less attractive. This is less so for Saudi Arabia as the Saudi trade payment needs (exports and imports) are much more aligned with the dollar. About 40 percent of Saudi imports are based or pegged to the dollar.
Fourth, it is much more important for policy makers to work on overhauling the subsidy system, micro economic issues and institutional and human capital reforms, rather than the exchange rate.
Furthermore, even a revaluation is not conducive as it will increase the fixed portion of the government outlays going forward, which are high to start with. One can think of devaluation in the medium-term rather than revaluation as Saudi Arabia steps us it industrialization drive and strengthens its economy.
The Saudi economy is soundly different from some other developing states engaged in more value-added exports. Such countries can employ exchange rates and other monetary policy tools to manage their economic systems.
The riyal-dollar peg still serves the Saudi economy until it can engender a far-reaching transformation of the economic development programs.
— Fawaz H. Al-Fawaz is a Riyadh-based