Pegged exchange rate — key factor for financial stability
Last Monday, the Saudi Arabian Monetary Authority (SAMA) affirmed its commitment to the exchange rate policy of pegging the Saudi riyal to the US dollar, a strategic choice that has supported economic growth in the Kingdom for over three decades.
At a time when financial centers around the world are experiencing volatility as a result of the COVID-19 economic shutdown, SAMA, the Saudi’s iron-fisted central bank, re-emphasized its policy to maintain the exchange rate at the official rate of SR3.75 to the US dollar as an anchor of monetary and financial stability.
Many friends and contacts ask me the question: Why do SAMA and many other central banks around the world peg their currencies to the US dollar? In fact, at least 66 countries either peg their currency to the dollar or use the dollar as their legal tender.
There are several reasons. The first is the fact that the US dollar is so popular because it’s the world’s reserve currency. Second, most of the financial and international trade transactions are priced in US dollars. Therefore, the dollar peg makes trade more predictable. As a result, countries decide to peg their currencies to safeguard the competitiveness of their exported goods and services and avoid volatility. Third, the dollar peg will stabilize exchange rates between trading partners.
In the case of Saudi Arabia and other oil-exporting nations, the dollar peg is a major strategy as oil in the world sold in US dollars. Besides, developing countries can use this system to prevent out of control-inflation. Bahrain, the UAE, Oman, Jordan, Hong Kong and Panama are among countries that currently peg to the US dollar.
SAMA is known worldwide as a reliable and credible regulator. Keeping the exchange rate system pegged to the US dollar will support local and international investments.
Currency stability is a critical factor when foreign investors consider investing in any country. In addition to the reasons listed above, the retail sector is one of the biggest beneficiaries of the pegged exchange rate system. Since profit margins are quite thin, any small shift in exchange rates may eliminate profits and force firms to find new suppliers or new markets. Hence, an exchange rate system pegged with the US dollar will support the local private sector in the country and will encourage foreign direct investors.
Basil M.K. Al-Ghalayini is the chairman and CEO of BMG Financial Group.