Saudi Arabia keeps markets guessing on revaluation

Saudi Arabia is keeping the financial markets guessing whether it intends to revalue its currency or leave it pegged to the US dollar and risk worse inflation rates.

Key financial institutions in the world's oil superpower said market speculation about a riyal revaluation has sharply receded but they felt an appreciation remains possible in the absence of other effective fiscal tools to tackle soaring inflation.

One institution cited a surge in deposits by foreign banks with Saudi commercial banks, which they said indicated those banks anticipate a revaluation.

"Financial market speculation on a revaluation of the riyal against the US dollar has eased significantly. One-year riyal forwards, which measure what the market expects the exchange rate to be in one year, are at their lowest level since November 2007," Riyadh-based Jadwa Investment said in a study.

"This follows clear statements from GCC central bank governors emphasising their commitment to the exchange rate pegs and progress towards the regional single currency. In addition, there is a growing consensus that the dollar has bottomed and that US interest rates will be raised before the end of the year. In contrast, we feel that revaluation is more likely now given that the government has no other policies open to it that would have a clear and immediate impact on inflation."

Saudi Arabia and its partners in the GCC have ruled out immediate plans to appreciate their currencies against the dollar, one of the main reasons for rising inflation rates in member states. But speculation persisted about a revaluation following a series of interest rate cuts in the GCC to match cuts by the US Fed aimed at preventing a recession.

"There has been a surge over the past months in riyal funding, inter-bank borrowing and Saudi banks' foreign liabilities, indicating there is still speculation about a revaluation," said the National Commercial Bank, the largest bank in Saudi Arabia.

Figures by the Saudi Arabian Monetary Authority (central bank) showed foreign liabilities, mostly deposits by foreign banks with Saudi banks, more than doubled in one year, peaking at SAR138.2 billion (Dh137bn) at the end of May compared to nearly SAR67.5bn at the end of May 2007.

The liabilities had remained almost stable during previous years before they started to swell in 2006. The increase was accompanied by a surge in banks' borrowing in riyals rather than foreign currency apparently in anticipation of a revaluation.

"It appears that some local banks are very actively raising finance in order to purchase assets underlying holdings of special investment vehicles that have been affected by the sub-prime crisis. Owing to concerns about a potential revaluation, banks are borrowing in riyals, rather than foreign currency," Jadwa said. "Riyal funding is being sought from local and international banks and this, combined with foreign banks positioning themselves in the event of a revaluation, has caused commercial bank foreign liabilities to almost double since August."

The report said the demand for riyal funding is also reflected in a SAR12bn increase in local interbank liabilities since December.

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