Saudi Arabian Riyal

Exchange Rate Regime: Fixed Monetary Authority: Saudi Arabian Monetary Authority Symbol: SR

Saudi Arabia’s central bank, the Saudi Arabian Monetary Authority (SAMA), was created by a royal decree issued by King Abdul Aziz Ibn Saud, the country’s first king, in April of 1952.
Decree No. 30/4/1/1046 established SAMA as the kingdom’s central bank, headquartered in the city of Jeddah. (Today the central bank is headquartered in the capital city of Riyadh).
The Authority’s charter was amended by royal decree in 1957.
SAMA’s 1957 charter mandates that the central bank shall maintain the value of the nation’s currency, act as the government’s banker, and regulate commercial banks:

The objectives of the Saudi Arabian Monetary Agency shall be: (a) To issue and strengthen the Saudi currency and to stabilize its internal and external value; (b) To deal with the banking affairs of the Government; (c) To regulate commercial banks and exchange dealers.

- Article 1 of SAMA’s Charter (1957)

Article 4 of the charter elaborates on the central bank’s role as the government’s banker, requiring the agency to hold the government’s revenues as deposits and pay out those deposits as the government spends money:

The Agency shall undertake the functions of the Government bank in receiving all Government revenues and in paying out funds in accordance with its instructions intimated to the Agency through the Minister of Finance.

- Article 4 of SAMA’s Charter (1957)

Dependence on Oil

According to OPEC, Saudi Arabia had roughly 267 billion barrels of proven oil reserves in 2018 (only Venezuela had larger proven reserves).
That year, the country produced an average of roughly 10.3 million barrels of oil per day.
Its exports of petroleum products were valued at roughly $194.36 billion for the year, accounting for roughly 70% of its export earnings.
According to OPEC, the oil and gas sectors comprised roughly 50% of Saudi GDP, with every other sector of the economy combined contributing the other 50 or so percent.
In 2018, Saudi Aramco – the state-owned oil company - was the world’s most profitable company with a net income of $111 billion, far exceeding the earnings of other multinational behemoths such as Apple ($59.5 billion) and Exxon Mobil ($20.8 billion).
The company paid the Saudi government $101 billion in taxes.
The fossil fuel industry thus comprises an astronomical proportion of the country’s economy and accounts for the vast majority of the government’s revenues.

Fixed Exchange Rate

As discussed above, Saudi Arabia is highly dependent on the sale of an international commodity – oil – to the world.
And, as the U.S. Dollar is the world’s reserve currency, the country receives payment for this all-important commodity in the American currency.
As a result, the country opted to try and keep the value of the Riyal – and by extension its earnings – stable relative to the U.S. Dollar (USD).
Since 1986, the central bank has maintained the exchange rate of the Riyal fixed relative to the USD at 3.75.
That is, one USD buys 3.75 SR and conversely, one SR buys 1/3.75, roughly 0.2667 USD.
SAMA intervenes in the forex markets as necessary to maintain this peg.
If the Riyal appreciates relative to the U.S. Dollar, the central bank sells Riyals and purchases Dollars, thus increasing the supply of Riyals and the demand for Dollars, and thereby, all else equal, causing the Riyal to depreciate relative to the U.S. Dollar.
On the other hand, if the Riyal depreciates relative to the U.S. Dollar, the central bank engages in the opposite transaction. It sells U.S. Dollars and buys Saudi Riyals in an effort to cause an appreciation of the Riyal relative to the Dollar.
Considering the dynamics of this latter operation – the exchanging of Dollars for Riyals to prop up the Saudi currency – leads us to the following question.
The Saudi central bank cannot create U.S. Dollars, so how does it accumulate the store of the American currency it needs to prevent depreciations of the Riyal?

Petrodollar Earnings and the Riyal Peg

The answer to the question of how SAMA acquires the U.S. Dollars needed to defend its Riyal peg is its sale of dollar-denominated oil.
As we stated above, Saudi Aramco receives payments for oil sales in USD and parks these petrodollars at the Saudi Arabian Monetary Authority, swelling the central bank’s war chest of Dollar reserves used to protect the currency peg.
These petrodollar earnings can then be sold off on the forex markets in exchange for Riyals to defend the fixed exchange rate as necessary.

Petrodollar Earnings and the Private Sector

When Saudi residents or private sector companies require U.S. Dollars, they turn to the country’s commercial banks.
These banks in turn can get access to U.S. Dollars from SAMA at a rate of 3.75 Riyals per Dollar.
In this way, Saudi Aramco’s sale of oil also supplies the U.S. Dollars needed by the Saudi Arabian private sector.

Saudi Arabia’s Fiscal Policy is Counter-Cyclical

The Saudi Arabian government’s fiscal dependency on the sale of oil means that its budgetary position varies with developments in the global oil market.
If the price of oil is too low, the government runs budget deficits: the revenue it earns from selling oil is lower than its expenditures.
These deficits are financed by issuing government bonds.
In April of 2019, the Saudi government’s breakeven oil price (the price at which the government’s revenues match its expenditures) was estimated to be over $80 a barrel.
Moreover, when the oil market is weak, the country runs external deficits (i.e. the value of the goods and services Saudi Arabia exports is less than the value of the goods and services it imports).
These deficits are met by running down forex reserves.
That is, because the country is paying out more to foreigners for imports than it is receiving in foreign currency from exports, it must use its reserves of foreign currency to pay for these imports.
On the other hand, when the oil market is strong, the government runs budget and external surpluses.
This means that forex reserves are replenished and government debt can be paid down.
Thus, Saudi fiscal policy is counter-cyclical: debt increases when oil prices, and thus the Saudi economy, perform poorly and decreases when oil prices are high.

Loss of Interest Rate Autonomy

Because Saudi Arabia chooses to maintain a fixed exchange rate between the SR and the USD, and the government has opted to allow capital to flow freely in and out of the country, Saudi Arabia gives up control over its domestic interest rates.
That is whereas, for example, the Bank of England changes its policy interest rates based on considerations within the domestic U.K. economy, the Saudi Arabian Monetary Authority cannot target interest rates that are not broadly in line with monetary developments in the United States.
Saudi Arabian policy interest rates are thus largely determined by U.S. policy interest rates.
International economists refer to this tradeoff as the “international trilemma” of open economy macroeconomics.
The trilemma states that a country can choose only two of the following three options simultaneously: free movement of capital, a pegged/managed exchange rate, and interest rate autonomy.
SAMA’s two key policy interest rates are the Repo Rate, the interest rate at which it lends to commercial banks, and the Reverse Repo Rate, the interest rate it pays on commercial bank deposits at SAMA.
Saudi Arabia has chosen to give up its interest rate autonomy in exchange for free movement of capital and an exchange rate peg.
To understand why it must make this tradeoff, consider the following simplified scenario.
Assume SAMA tries to simultaneously pursue all three options: free movement of capital, an exchange rate peg, and monetary policy autonomy.
Now suppose that the U.S. Federal Reserve raises its policy interest rate.
The policy of allowing capital to move freely in and out of Saudi Arabia means that money will flow out of the country and into the U.S. to take advantage of higher interest rates there.
This would be expected to cause the U.S. Dollar to appreciate relative to the Saudi Riyal: as capital flows out of Saudi Arabia, Saudi Riyals are sold for U.S. Dollars that can earn a higher interest rate.
And the depreciation of the Saudi Riyal relative to the U.S. Dollar would cause the exchange rate to fall below the targeted 3.75 level.
Alternatively, Saudi Arabia could restrict the free movement of capital in and out of the country. This would prevent the flow of capital out of Saudi Arabia that results from the interest rate differential between the two countries.
But it has opted to allow the free movement of capital.
Thus, given that it insists on free movement of capital and maintaining a fixed exchange rate, Saudi Arabia is left with only one option: SAMA must increase its policy interest rates in line with the increase in the U.S. to prevent the flow of capital out of the country, and thus, prevent the depreciation of the SR relative to the USD.
SAMA thus cedes control over its interest rate policy to international developments: it cannot target interest rates that are significantly out of line with U.S. interest rates.
For example, when the U.S. Federal Reserve decided to raise its target range for the Federal Funds interest rate by 25 basis points on December 19, 2018, the Saudi Arabian Monetary Agency immediately responded by raising its two key policy interest rates by 25 basis points.

The Federal Reserve Bank of New York, one of the regional branches of the US Federal Reserve. The Saudi Arabian Monetary Authority moves its policy interest rates in line with changes in the Federal Reserve’s target Fed Funds range.

Written By: Aiden Singh Published: May 17, 2020 Sources

Saudi Arabian Riyal

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