Saudis may be forced to devalue riyal

|Arabian Post Special|If oil prices fall further from the current levels, it would lead to a quick buildup of pressure on the Saudi riyal’s 30-year peg to the dollar, forcing the Saudi authorities to de-peg and devalue the currency, Bank of America-Merrill Lynch said in a report.

“And frankly, it is a lot easier politically at first to deliver a modest crude oil supply cut than to implement a full-blown currency devaluation,” BoAML analysts said.

Saudi Arabia has been forcing oil prices lower by increasing oil production in an oversupplied market, and it has also rushed to issue debt in its local market to fill a soaring budget gap. But the important question is how long can the government maintain this dual strategy of flooding the oil market and draining its forex reserves.

“In our view, it is unlikely that Saudi leaders would want to exacerbate the ongoing reserve drain by pushing Brent prices below $40 per barrel,” the report pointed out.

A sharp move by the Chinese currency could ultimately force Saudi’s hand. A de-peg of the Saudi riyal is thus the number one “black-swan” event for oil in 2016, the report says. If the CNY does indeed fall to 6.90 against the dollar, as the bank’s forex team is calling for, many emerging market currencies could experience a second leg down. For oil, however, the most crucial point is what happens to Middle East currencies and in particular to the Saudi riyal, the report argues.

Saudi Arabia’s forex reserves are still high and point to an ample buffer for now, but they have been falling at a relatively fast rate, the report points out. However, should China allow for significantly faster currency depreciation than is currently priced in by markets, BoAML believes oil prices could fall further.

Naturally, the forex reserve drain on Saudi could accelerate to $18 billion per month if Brent crude oil prices average $30 per barrel, sharply reducing the kingdom’s ability to retain its currency peg.