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Saudi will not de-peg or devalue riyal

mateininvest|By Matein Khalid| The collapse in Brent crude oil below $30, a 20% fall in the Tadawul share index in January 2016’s global equity bloodbath, the cut in fuel subsidies and geopolitical risk escalation in the Middle East has spawned speculation in financial markets that Saudi Arabia will devalue the kingdom’s riyal, now pegged at 3.75 against the US dollar. Senior princes of the royal family and the governor of the Saudi Arabian Monetary Agency (SAMA) have reaffirmed Riyadh’s commitment to its US dollar peg, a source of economic stability in the Gulf for the past two generations. I agree with Saudi Arabia’s financial policymakers that there is no need to abandon a dollar peg that has served the kingdom so well ever since the 1980’s during times of war and peace in the Middle East, during times of inflation and deflation, during times of oil booms and oil busts. My call? Saudi Arabia will not abandon its US dollar peg. Why?

One, Saudi Arabia, unlike Russia or Canada, imports most of its food. A devaluation of the Saudi riyal would raise food prices, lead to consumer inflation and violate the social contract between the House of Saud and the Saudi population.
Two, Saudi Arabia faces a $98 billion budget deficit that is 17% of GDP. Yet Saudi Arabia has also amassed $640 billion in state hard currency reserves managed by SAMA. Saudi Arabia has miniscule public debt, unlike in the Sheikh Yamani era oil bust in the 1980’s. Saudi Arabia can easily issue $20 billion in sovereign Eurobonds in the international capital markets as well as borrow another $20 billion in the Saudi riyal money market. Devaluation is far too draconian a policy response for a de facto liquidity, not solvency crisis. Saudi Arabia has begun the process of fiscal austerity and government borrowing has led to a rise in Saudi riyal rates above LIBOR in the money markets.
Three, ever since the reign of the late King Faisal, Saudi Arabia’s dollar peg has symbolized the innate financial conservatism of the world’s largest crude exporter, the royal family’s commitment to preserve a stable business climate for the kingdom’s merchant elite and foreign investors and the geopolitical realities of the oil for security alliance with Washington, forged by President Franklin D. Roosevelt and King Abdul Aziz Al Saud, founder of the kingdom, aboard a Red Sea warship in 1945. “Riyalpolitik” preludes devaluation. After all, Saudi Arabia survived the 16 year oil bust in the 1980’s and 1990’s without a devaluation. It will survive the next decade with its US dollar peg intact.
Four, oil is 60% of Saudi Arabia’s GDP and 85% of the government budget. Unlike Canada or Australia, Saudi Arabia enjoys no J-curve export boom if it devalues the riyal. The world oil market is denominated in US dollar, which also happens to be the world (and SAMA’s) reserve currency. There is simply no macroeconomic or export benefit to devaluation.
Five, the recent budget freeze and subsidy cuts reinforce the kingdom’s commitment to fiscal reform, as well as opening its capital markets to foreign institutional investors. Economic institutions such as SAGIA and the CMA reflect the kingdom’s eagerness to attract foreign investors and integrate its $750 billion economy, the largest in the Arab world, with global capitalism. The Saudi riyal’s dollar peg is a fundamental pillar of the kingdom’s main appeal to foreign investors and corporate titans.
Six, even though SAMA has drawn down $100 billion from offshore fund managers, its hard currency reserves exceed $640 billion. Wall Street and the City of London’s cognoscenti know that SAMA can and will defend the dollar peg with its epic financial firepower.
Seven, the 2016 Saudi budget envisages 14% cuts in government spending and a rollback in subsidies and lavish welfare benefits. Crown Prince Mohammed bin Nayef and his deputy Prince Mohammed bin Salman both appreciate that a stable Saudi riyal boosts social stability at a time of fiscal belt tightening. As the kingdom cuts spending, its budget deficit will shrink and reassure investors. Saudi Arabia does not want or need higher food inflation, imported goods price increases or the loss of offshore investor confidence that could well follow devaluation. So “Realpolitik” and economics suggest Saudi Arabia will not devalue the riyal.
Macro Ideas – The mystery and enigma of Switzerland
Switzerland has fascinated and baffled me my entire life. Why do chalets in Verbier and Gstaad cost five times more than in, say, the French resort of St. Gervais? Are people really willing to pay five times more for jet set, après-ski snobbery in the Swiss cantons? In any case, does climate change mean no snow in the Swiss Alps but plenty of white powder in Ski Dubai? Why does a visit to a supermarket on the Rue de Rhone feel like a bank heist while Chamonix or Ferney Voltaire in France are not trop cher? Why did Switzerland’s oldest bank, Wegelin of St. Gallen, whose partners I am proud to call friends, not survive 2008 but UBS and Credit Suisse are the pillars of the Helvetica Inc. money changers temple? Why did the Swiss National Bank kill the world’s top hedge funds, the gnomes of Mayfair and Greenwich, Conn with its shock abandonment of the 1.20 Euro ceiling peg?
Why did Ian Fleming, James Bond’s creator depict Swiss bankers in such a sinister light when he himself was the scion of a Scots merchant banking clan that made a killing in colonial Hong Kong? Is it true that Adolf Hitler, Brezhnev, the Shah of Iran, Marcos, Kremlin oligarchs, Nigerian military dictators (notably Sani Abacha), the Indian subcontinent’s political elite all stashed their looted billions in Swiss banks via numbered accounts? How much of Switzerland’s $3 trillion in offshore wealth was looted from the planet’s most corrupt and impoverished dark alleys? Why do so many Iran linked Indian and Pakistani business oligarchs operate Swiss banks accounts? Why are so many Lugano banks for sale and being pitched to Gulf financiers? Is Lugano run from Milan, Bern or an anstalt in Lichtenstein? Why did the Swiss police raid the HSBC Private Bank in Geneva? Why did the German intelligence service pay millions of Euros to a computer operator to acquire lists of secret account holders in a Swiss bank owned by the princes of Vaduz? Switzerland is definitely not just about skiing, yodeling, Heidi, Toblerone or the cuckoo clock.
Montreux on Lake Geneva is my favourite place in the Swiss Riviera, thanks to the ghost of Vladimir Nabokov and Graham Greene. The Jazz Festival made music history. Smoke over the water, fire in the night. The world knows Arab London (Edgeware Road and shish touk in Belgravia) but Arab Geneva is also a summer hub. The jet d’eau even reminds me of the Sharjah Corniche. Many Saudi family offices once based in Geneva are moving to DIFC. The luxury watch makers of the Jura are now all in Dubai Mall. Is it time for my Swissies to suntan in the Bernese Oberland?
The SNB has triggered a deflation shock in the Swiss economy. Euro-Swiss is now 1,09, making it difficult for Swiss industrial exporters or tourist hubs to compete in global markets. The jobless rate has risen to ten year highs. Exports to the EU and China have sagged. The Russian can no longer afford to party in the Orthodox Christmas break with their battalions of meanie bodyguards and six foot tall blonde secretaries.
I believe the Swiss franc is the most overvalued currency in the G-10, though a safe haven in Wall Street risk aversion spasms. I was shocked to see cable car revenues fell 15% this winter (no snow? No tourists?) This is a disaster for tourism dependent cantons. Unmoglich Quelle horreur. Mamma Mia! The SNB must act. The SNB will act – and short Swissie is my next big macro call.
The short Canada trade is now over. I would now buy the loonie at 1.45 for a strategic 1.38 target. Why? I expect Janet Yellen to do a policy U turn (in words at least) when she is grilled by her senatorial inquisitors during Humphrey Hawkins. Oil has popped every February since Desert Storm and will pop again if the stars are aligned, dear Brutus. The momentum/signals on the charts scream long loonie. Risk reversals, option skews, Chicago IMM futures data confirm. Ottawa will shift policy now that inflation is 2% and Canadian exports to the US benefit from the J-curve. Evening stars. Stabler China and metals. My call? Canada will rise to 1.38 by March. First law of Nataknomics. No guts, no glory.
Market View – Value strategies in Hong Kong and Indian equities
Asian equities trade at fairy tale valuations though I know value traps and macro minefields can fleece poor leveraged lambs to the slaughter. Baa baa bankrupt sheep, have you any wool? Asia ex Japan trades at 1.2 times book value and 10.8 times earnings, valuation I last saw in 2002 (Hong Kong SARS), 2008 (Lehman) and 2001 (9/11, TMT bust). The 1998 Asian flu taught me there is nothing sacred about book value, especially in emerging markets where creative accounting would put fiction writers like Stephen King to shame. Nor do I think it is a good idea to go long Asian currencies against King Dollar. Not yet, in any case.
Hong Kong H shares are down 13% in 2016 amid the monetary neutron bomb explosion in Shanghai/Shenzhen. Would I buy the Hang Seng China Enterprise Index? No. Index investing is an idiot’s game as it overexposes a portfolio to companies/risks that I do not want. Not usually. Yet when Hong Kong H shares trade cheaper than shares in Pakistan and Oman (half Muscat shares trade below book value), it is time to review “one country, two systems, the Crown Colony that gave the world Bruce Lee, the Star Ferry, Wanchai Suzie Wong and CLSA. Hong Kong H shares now trade at 6 times earnings after the carnage. No typo here. Six times earnings. This is the danse macabre of a wounded, dying El Torro, whose Relative Strength Index is now 23.
The cognoscenti in Dragonmart advice me to embrace the Chinese consumer, to buy insurer China Life and Internet/auto shares while avoiding the banks/state metals dinosaurs like the plague. One exception. Bank of China at three times earnings (Value Baba, kiya!). This is what happens when a credit bubble goes bust even though Beijing’s central bank tells us that non performing loans are only 1.5%. Right – and I am the Emperor of Greenland and Graceland. China’s property developers crashed 20% in January 2016 alone, thanks to their US dollar debt load. Yet Vanke has hedged its US dollar/Hong Kong borrowings. The HSCEI traded at 15,000 last May. This puppy is just above 7900 now. Six times earnings, like Putin’s Kremlin.
Even though the Sensex has fallen 4000 points since my 18,000 Sensex call was published last spring, India still commands a valuation premium at 16.8 times earnings that I think is totally unjustified. Why? The RBI’s new policy on provisions and the BJP’s political witch-hunts against the Maharajahs of Black Money make it certain that India’s credit goosed GDP growth rate will disappoint. As offshore funds flee Dalal Street, the rupee gets slammed despite the $60 billion windfall of $28 Brent. The failure to pass the Goods and Services (GST) tax or the land acquisition bill, the shock political defeats in New Delhi and Bihar have taken the mickey out of Modinomics. The valuations of Indian banks and my own failed ICICI Bank trade (et tu, Chanda?) tell me that India is on the edge of a systemic banking credit crisis as Oligarch Wallah’s billions in offshore borrowing sprees come home to roost. This means the Indian rupee plummets to 72 – 74 by year end if Dr. Rajan gets it right and 80 – 82 if the Tamil Milton Friedman gets it wrong. Yet can Modi and Chicago School monetarism coexist? No.
So Asia ex Japan’s consensus darling trades at 3 times book value. As Jeeves might observe poppycock Bertie. This is hunky dory if earnings growth was on a roll but this is not so, thanks to the grim realities of global growth, world trade, the China shock, fiscal austerity and PPI deflation. I worry about capital flight and Dr. Rajan flight (back to the non-ivy cloisters of Chicago’s South Side) on the Indian rupee. So I love the Infosys ADR, a tad expensive at 18 times earnings but a play on a lower rupee, Big Data, cloud and app development. India was the Jewel in Crown of both the British Empire and the Morgan Stanley emerging markets index. But all good things come to an end. The great Indian bull market has now turned as lethal as the bite of a Raja Naga-Cobra.
Written by

Mr. Matein Khalid serves as Head of Capital Markets and Advisor to the Chairman at Bin Zayed Group LLC. Mr. Khalid serves as the Chief Investment Officer of Salama. He manages Bin Zayed's global equities portfolios in the US, Russia, Latin America, Europe and the Far East. He is responsible for the Bin Zayed's hedge funds / private equities portfolios and external fund manager selection. He also advises the Chairman and board on investment banking relationships, financing and new issues in the international debt markets and merger/acquisition deal flow. Mr. Khalid has 20 years experience in the international capital markets and has worked with investment banks, private banks and securities firms in New York, London, Chicago, Geneva, Abu Dhabi and Dubai. He is an adjunct professor of banking and finance at the American College of Dubai, where he is also a member of the Board of Directors. Mr. Khalid writes on global financial markets and Middle East studies for newspapers and magazines in the UAE, Bahrain, Oman, Qatar and the United States. He has also taught courses on capital markets at J.P. Morgan Chase, (New York), SP Jain and Emirates Institute of Banking (Dubai). He has also taught at capital market seminars at Morgan Stanley (London), Chase Manhattan Bank (Geneva) and Barclays Capital (Hong Kong). Mr. Khalid has briefed ASEAN finance ministers and ultra high net worth investors in Hong Kong at the invitation of the chairman of Barclays Capital. He holds an MBA in finance and BS in Economics from the Wharton Business School and a BA/MA in international relations from the University of Pennsylvania in the US.