January 12, 2016 6:00 pm JST
Currency turmoil

Saudi Arabia scurries to keep dollar peg as oil producers feel heat

KAZUHIRO KIDA, Nikkei staff writer

LONDON -- The currencies of oil producing countries are taking a beating as the plunge of crude continues.

     In the futures markets, investors are pricing in possible currency devaluations by Saudi Arabia and other Middle Eastern countries. Russia and other oil producers, meanwhile, are struggling with depreciation of their currencies. A weaker yuan is exacerbating the situation.

     The Saudi Arabian Monetary Agency said on Monday that it will take every financial policy measure, including the use of foreign currency reserves, to maintain the riyal's peg to the dollar. The country has kept the peg at 3.75 riyals to the dollar since 1986. 

     Many oil producers use dollar pegs, since crude oil is basically traded with the greenback. Futures investors, though, are speculating that the peg system could collapse. In Saudi Arabia's case, this has brought the one-year future rate to 3.85 riyals to the dollar, the weakest on record.

     The pressure on the riyal comes as falling oil revenues raise concerns about Saudi Arabia's fiscal deficit. In the credit default swap market, participants are factoring in a more than 10% chance that Saudi Arabia will default on its bonds. Moreover, there is a limit to how long the kingdom can sustain the dollar peg by purchasing its own currency.

     Saudi Arabia's foreign currency reserves stood at 2.38 trillion riyals ($634 billion) at the end of November, down 15% from the peak in the summer of 2014.

     Rather than abandoning the peg, there is a possibility that Saudi Arabia will shift to a currency basket system, according to Luis Costa of Citigroup.

Fragile ruble

The currencies of Oman and other Persian Gulf oil producers, too, are facing heavy pressure. So is the Russian ruble and other currencies of oil producers on the floating exchange rate system.

     The ruble is trading between 76 and 77 to the dollar, close to the record low of about 80 seen in December 2014. For a while now, Russia's central bank has been trying to determine when to cut interest rates to spur economic growth. Analysts think the weakening ruble may force the central bank to postpone such a move.

     In the worst-case scenario, the exchange rate could drop to around 100 rubles to the dollar, said Piotr Matys, an emerging market analyst at Rabobank.

     Russia is not alone. The Brazilian real is also depreciating quickly against the dollar.

Line of dominoes 

Other oil producers with weak economies have been forced into drastic measures, including devaluations. Earlier this month, Angola, in western Africa, weakened its currency, the kwanza, from 134 to the dollar to 154 -- a more than 10% decline.

     The kwanza had been under pressure after the recent U.S. interest rate hike. And the country's dwindling foreign currency reserves made it difficult to shore up the rate.

     In late December, Azerbaijan switched to the floating exchange rate system. And to hedge against currency depreciation, Nigeria has introduced tough controls on foreign exchange. While visiting the African country on Jan. 6, Christine Lagarde, the managing director of the International Monetary Fund, said she did not support those restrictions.

     In Egypt, there is talk of further devaluing the nation's relatively strong currency, the Egyptian pound.

     Market watchers believe that China is allowing a weaker yuan. This has fueled the selling of oil producers' currencies, making it more difficult for them to respond. More speculative selling could undermine the peg system in Saudi Arabia and other oil producing states.

     That could trigger a depreciation domino effect around the globe.

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