Saudi Arabia cracks down on riyal speculation

Pressured by plunging oil prices and costly wars in the Middle East, Saudi Arabia moved to stamp out speculation that it might be forced to break the link between its currency and the dollar.

Authorities this week ordered banks to limit traders’ ability to bet against against the riyal, whose peg to the dollar has been a bulwark of the kingdom’s economic and financial stability since its introduction three decades ago.

Officials aimed “to kill this speculative activity over the sustainability of the riyal peg,” Apostolos Bantis, a credit analyst at Commerzbank AG, said by phone from Dubai. “Over time, this measure will lead to an easing of the forwards because it will make it far more risky for investors to do this trade.”

Financial Crisis

While few economists predict a devaluation is at hand, the move nonetheless underscores the financial crisis confronting the kingdom. The ruling al Saud family has taken unprecedented measures to reduce its reliance on oil. The government last month raised fuel prices and trimmed spending to narrow a deficit that may have been the widest since 1991 last year. It floated the possible sale of a stake in the state-owned oil company, Saudi Aramco.

Countries with currencies pegged to the dollar, such as Saudi Arabia and Hong Kong, are coming under increasing pressure from traders speculating that it’s become too expensive for policy makers to continue defending exchange rates as the U.S. currency soars. Bets for a devaluation of the riyal reached their highest in about two decades in January, even after the Saudi Arabian Monetary Agency said for a second time in four months it will stick with its currency peg.

With speculation mounting that the strain from the lowest oil prices in 12 years would be too much for the peg to bear, the monetary agency told lenders to halt the sale of options contracts on riyal forwards, according to five people with knowledge of the matter. The directive, issued at a Jan. 18 meeting in Riyadh, applies to local banks and the Saudi branches of international banks, the people said.

The central bank declined to comment when contacted by telephone Wednesday.

The crude drop comes as tension between the Sunni-led state and Shiite-majority Iran escalated after the execution of a prominent Shiite cleric and the dropping of most international sanctions against the regime in Tehran.

Saudi riyal forwards for the next 12 months rose to 967.5 points as of 6:29 p.m. in Riyadh. The nation’s benchmark stock gauge, the Tadawul All Share Index, dropped 5 percent, bringing its loss to 21 percent so far in 2016.

While Saudi Arabia has been burning through more than $100 billion of its foreign reserves the past year, the stockpile, at about $628 billion at the end of November, is still the third largest in the world after China and Japan. The Arab state may sell shares in Aramco in an initial public offering as part of a broader package of economic reforms. About 70 percent of the nation’s revenue comes from oil.

“They would cut oil output first and increase prices before moving on the peg,” John Peta, head of emerging market debt at Old Mutual Global Investors in London, said by e-mail.

Volatility in the forwards market has been based on “misperception about Saudi Arabia’s overall economic backdrop,” Governor Fahad Al-Mubarak said in a statement on Jan. 11. The kingdom will “uphold its mandate” of maintaining the three-decade old peg at 3.7500 per dollar.

The policy has “has served Saudi Arabia well,” Masood Ahmed, director of the Middle East and Central Asia department at the International Monetary Fund, said in an interview. “It remains appropriate given the structure of the economy. Also Saudi Arabia has adequate buffers to maintain this peg.”

The Washington-based fund on Tuesday lowered its 2016 forecast for economic growth in Saudi Arabia to 1.2 percent, its slowest pace since 2002.-Bloomberg