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29 March 2024

Saudi to keep dollar peg in 2011

Turning to interest rates in the Kingdom, the world’s oil superpower, the study expected them to remain low throughout 2011. (SUPPLIED)

Published
By Nadim Kawach

Saudi Arabia is set to keep its currency the riyal pegged to the US dollar as it is expected to remain on the same track as in 2010 while inflation will remain relatively high, a key investment centre in the Gulf Kingdom said on Monday.

Although the Saudi Arabian Monetary Agency (SAMA), the country’s central bank, might slightly raise interest rates towards the end of 2011, they will remain at historical low levels, the Riyadh-based Jadwa Investments said.

In a study sent to Emirates 24/7, Jadwa said SAMA could move rates up independently from the US because of an expected recovery in domestic bank credit following a sharp slowdown in 2009 and 2010.

“The riyal will remain pegged to the US dollar during 2011. We do not expect any serious discussion on breaking the peg or speculative pressure against the peg. Dollar movements are likely to be driven by the same themes as 2010; weakness in developed economies and strength in emerging economies,” it said.

“As with 2010, we expect currency movements will be volatile and subject to swings in sentiment about the relative health of the economies of the US, Japan and Eurozone. These are likely to cancel each other out over the course of the year and therefore think the dollar will be relatively little changed during 2011.”

It said that consensus forecasts point to a modest strengthening of the dollar against euro and weakening of the dollar against yen by the end of 2011.

It added that a further depreciation of the dollar against emerging market currencies is anticipated as the more robust performance of emerging economies will continue to draw in financial flows from developed economies, which will be exacerbated by creation of very cheap money through quantitative easing.

To manage these inflows, more countries are expected to resort to capital controls, which could raise international trade tensions, it said.

According to the report, the main pressure point is currently the inflexibility of the Chinese yuan.

“There are unlikely to be formal US sanctions against China for currency manipulation, but pressure for swifter appreciation of the yuan will remain strong, not just from the US, but increasingly from emerging markets, as most emerging market currencies have appreciated strongly against the yuan…. faster yuan appreciation appears inevitable.”

Jadwa noted that the strength of emerging market currencies against the Saudi riyal could well put upward pressure on inflation, as emerging markets are becoming an increasingly important source of imports.

Its figures showed a drastic change in the sources of the Kingdom’s imports between 2004 and 2009. Emerging markets were the origin of 42.8 per cent of total imports in 2009 compared to 36.6 per cent in 2004, it said.

“Stripping out the countries with dollar pegs in the GCC lowers the totals to 37.9 per cent in 2009 and 31.8 per cent in 2004. China was the fastest growing supplier of imports over this period and is now the second largest source of the Kingdom’s imports, so the anticipated appreciation of the yuan against the riyal

is likely to be reflected in higher prices for Chinese goods in the Kingdom.”

Turning to interest rates in the Kingdom, the world’s oil superpower, the study expected them to remain low throughout 2011.

“The exchange rate peg to the US dollar and the lack of capital controls mean that interest rates in the Kingdom need to broadly shadow those in the US. We see little chance of noticeably higher interest rates in the US in 2011,” it said.

“Currently, the US is loosening monetary policy. With the main US interest rate, the Fed funds rate, effectively as a low as it can go, the Fed is stimulating the economy through the creation of new money known as quantitative easing.”

The report said it is too early to determine whether the current programme of quantitative easing, set to run until the middle of 2011, will then cease.

But it noted that even if it ceases, it will not signal that a rise in interest rates is imminent, adding that it expects the US Fed funds rate to remain unchanged.

“SAMA has some scope to move interest rates independently from the US and we do anticipate a modest increase of 0.25 percentage points in both the repo and reverse repo rate towards the end of the year,” Jadwa said.

“We think this will be prompted by the gradual normalization of bank credit conditions and more specifically, by the likely return of annual bank lending growth to close to double-digits….. the other instance in which SAMA would look at hiking interest rates would be if serious domestic inflationary pressures emerge, which we do not anticipate.”

Jadwa said that although inflation will remain high, it will be driven by rents and imported price pressures and will therefore not be affected by interest rates.

It added that there are other policies that could be adopted to encourage banks to lend more, such as reducing reserve requirements, increasing government deposits in the banks and reducing outstanding debt.

“As the issue is the unwillingness, rather than the inability, of banks to lend, it is unlikely that any of these would be effective and we do not expect any of these changes to be implemented.”