RIYADH, 6 December 2004 — How much further can the dollar fall? In addition to the twin US deficits, it depends on political factors as well.
If the US fails to stem the dollar’s erosion (as expected by most analysts, from comments made by senior US officials), key trading partners like the euro zone, Japan and other East Asian countries can try to force the US’s hand by attempting to depreciate their own currencies and lowering interest rates.
The East Asian countries and Russia have a war chest of over $2 trillion in forex reserves (Japan: $837 billion, China: $514 billion, Taiwan: $235 billion, India: $122 billion, Russia, $114 billion; Hong Kong: $100 billion) at their disposal.
Some analysts expect the dollar to fall to $1.45/euro before foreign countries’ patience with the dollar runs out.
What impact does a falling dollar have on Saudi Arabia? The headline impact that most people understand is the reduction in the purchasing power of Saudi Arabia’s most precious commodity, oil (because it is priced in dollars).
However, all elements of the Kingdom’s international trade should be considered — imports, exports, and the Kingdom’s external financial assets and liabilities.
Since October 2000, the dollar has fallen 59 percent against the euro.
This means that Saudi imports from euro countries are 59 percent more expensive.
Similarly, Saudi imports from other non-dollar countries (Japan, South Korea etc.) will also become more expensive.
However, Saudi imports from dollar-peg countries like China will not become more expensive.
On the export side, Saudi non-oil exports (primarily petrochemicals) will benefit from the dollar’s slide because they become cheaper to non-dollar importing countries.
On the asset side, the dollar’s slide reduces the value of the Kingdom’s dollar assets held (e.g., US treasuries and private securities, US dollar reserves, dollar deposits abroad) and reduces the value of its dollar liabilities.
The impact of all these on the Saudi economy is complicated and difficult to quantify.
Normally, imports will rise initially, (because import volumes cannot adjust to the higher prices immediately).
Similarly, increased government imports will increase government spending (and hence its budget deficit).
Rising cost of imports, especially imported machinery and raw material, will adversely affect private economic activity and government project spending.
Over time, as import volume adjusts to higher prices, the decline in the country’s current account surplus will be reversed to some extent (the J-curve effect).
On the financial assets and liabilities side, the net impact will be a fall in the country’s net overseas wealth position, thereby affecting consumption, investment and imports (the “wealth effect”).
In recent months, the Saudi economy has been hit by a double whammy — that of the falling dollar and falling oil prices.
Thus, not only are the oil dollars buying less, but the country is also getting fewer dollars to start with.
Many have suggested that the problem can be resolved by pricing oil in euros! Some would argue that this, combined with the Saudi riyal peg to the dollar, would be a double boon.
This way, the revenue stream is in the stronger currency (euro), while the spending outflow is in the weaker currency (the dollar).
Moreover, non-oil exports are encouraged by the cheaper riyal, thereby maximizing the country’s external balance.
If it were an individual investor or business, there would be no question about it.
But, for a country, the issue is not as simple.
One has to consider the greater impact of switching to euros.
First, is the euro’s rise temporary because, if so, then the country will be faced with the same dilemma when the euro falls.
Second, if all countries switched to euros, it will hasten the decline of the dollar.
For a thorough evaluation of the impact of switching from dollars to euros, the Kingdom needs to consider four key aspects of it “dollar-peg” policy together: (1) Pricing of oil in dollars. (2) the Saudi riyal (and riyal interest rates) peg to the dollar. (3) the country’s trade pattern vis-à-vis dollar and non-dollar economies, and (4) the country’s overseas net financial asset position in dollar vs. other currencies.
(Khan H. Zahid is chief economist and vice president at Riyad Bank. He is based in Riyadh.)
