Saudi urged to cut investment in US

Saudi Arabia should cut its investment in US bonds to protect its overseas assets following the credit downgrade of the United States given the Gulf Kingdom’s heavy reliance on the US market, the country’s largest bank said on Thursday.

Besides the impact of the downgrade on Saudi foreign assets, the problem could also have indirect effects on Saudi Arabia by depressing oil prices and the value of the US dollar, to which the Saudi currency, the riyal, is pegged, National Commercial Bank (NCB) said in a study sent to Emirates 24/7.

Citing its own sources, NCB said it believes US treasuries constitute the majority of Saudi Arabia’s net foreign assets of nearly $492 billion.

It described the downgrade as actually more of a referendum on the dollar rather than US treasuries, due to the fact that US ability to pay its debt obligations remains a “fundamental certainty”

“This is because the dollar remains the world’s reserve currency and the US government can continue to print money to fund its obligations. Therefore, holders of US treasuries like Saudi Arabia should not be concerned that they may not receive interest payments on US bonds,” NCB said.

“However, the value of those payments will essentially decline, given the fact that with more dollars in circulation due to the printing presses, the value of each dollar by definition declines….since the Kingdom is keeping much more than enough to maintain the peg of the riyal to the US dollar, it is advisable that the Kingdom should opt for diversifying future excess revenues away from US treasuries into other real assets across different currencies and regions.”

Another effect of the US downgrade on Saudi Arabia is that it could depress oil demand and prices on the grounds that the United States is the world’s largest oil consumer, according to the study.

In addition, recent concerns that Europe’s debt crisis could spread to Italy, the Euro-zone’s third-largest economy, accentuated fears of a vicious new global economic downturn, it added.

 The study noted that oil prices sank more than $10 a barrel last week, highlighting just how quickly commodity markets can swing in the peak of a crisis, and continued to sag below $80 a barrel.

Apparently, the drop in prices reflects the market's revision to expected demand growth, it said, adding that Light sweet crude for September delivery, fell $2.08, or 2.56 per cent, on Monday to around $79.23 a barrel.

Meanwhile, Brent North Sea crude for September delivery dropped $1.21 or 1.17 per cent to $102.53. “More volatility in oil prices can be expected in the near-term as financial investors reduce their long positions on the back of risk aversion and the uncertain global economic outlook,” NCB said.

“However, we believe, that the fall in oil prices may be nearing an end. This would be especially true if the FED steps up its purchases of US government bonds. However, even if oil prices fall below $80, Saudi Arabia will not have a great impact as it enjoys a large reserve to meet its planned spending.”

NCB said a third impact is through the US dollar, whose response against most currencies will likely follow broader market developments.

“As equity and commodity markets keep falling, investors are likely to cut long positions. These are mainly funded by short US dollar, so whether or not the safe haven status of the US dollar is impaired over the long-term, a downward shock to markets is likely to be US dollar positive in the near term,” it said.

“There are contradictory forces at work with the pull down from the credit rating and the push up from an equity market disturbance, for as stocks are sold and dollars are bought. ….. although this is positive for the US dollar in the short-term, once things settle down, as noted earlier, the downgrade would have a negative impact on the US dollar.”

NCB said that while investors instinctively may want to sell US dollar and buy euro, the euro sovereign issues do not look better because the US’ looks worse. “With the impact of S&P’s credit downgrade being positive on the US dollar in the short-term, it is unlikely to raise the level of imported inflation in the kingdom, especially that commodity prices are falling,” it said.

“However, weaker US dollar in the long term, due to the S&P’s downgrade, may eventually contribute to higher imported inflation.”

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