The COVID-19 pandemic has presented a challenging period for the gulf currencies, particularly following the slump in oil prices at the start of the crisis.
rude oil futures tumbled to record lows in April 2020 as lockdowns around the world sapped demand for commodities. This put pressure on the currency pegs in the Gulf Cooperation Council (GCC) and rekindled bets among some investors that one or two of these pegs were at risk of being ditched. The Omani riyal, for instance, fell to an all-time low against the dollar in the forward market, with ratings agency Standard & Poor’s cutting the country’s outlook and warning that confidence in the currency’s peg could diminish.
The situation has taken a dramatic turn for the better since then. The rapid rollout of the various COVID-19 vaccines around the world fuelled hopes of a swift recovery in the global economy and has contributed to the sharp uptrend in oil prices – Brent crude oil futures are now back up to around $70 a barrel at the time of writing. While this remains below the breakeven oil price for some GCC nations, the minimum price required for spending needs to be met while balancing its state budget, pressure on the pegs has dramatically lessened. We now see little to no risk at all that any of them will be abandoned any time soon.
Figure 1: Global Brent Crude Oil Futures (2018 – 2021)
Source: Refinitiv Datastream Date: 08/06/2021
We have outlined in this report our view as to the vulnerability of each peg to devaluation. We believe that this vulnerability depends heavily on both the ability of the country’s central bank to defend the peg and also the suitability of the exchange rate for each country’s domestic economy. The key factors that we look at in considering each currency’s vulnerability are:
- Foreign exchange reserves & sovereign funds in relation to imports.
- Current account balance as a percentage of GDP.
- Public debt levels as a percentage of GDP.
We have listed in the table below the above variables for the pegged currencies in the gulf region and the forward discount for each currency. The latter represents the magnitude of devaluation expected by the market and combines to give us a decent indication as to the likelihood of devaluation. As you can see, these forward discounts have declined fairly markedly for most currencies since the peak of the market panic in April 2020, particularly in the case of the Omani riyal, suggesting that pressure on the pegs has considerably lessened.
|Spot Exchange Rate vs. USD||3.75||3.67||3.69||0.38||0.38||0.30|
|FX Reserves (US$ billions)||449||105||55.6||17.4||3.2||44.5|
|Sovereign Funds (US$ billions)||900||1363||345||14.3||18.6||534|
|FX reserves and sovereign funds as total months’ worth of imports||42||83||166||14||10||85|
|Current Account Balance (% of GDP) ||-2.8%||+5.9%||-2.5%||-5.2%||-2.1%*||+0.8%|
|Public Debt (% of GDP)||32.5%||36.9%||71.8%||55.9%||128.3%||11.5%|
|1 Year Forward (28/05/21)||3.7525||3.6735||3.7064||0.3860||0.3786||0.3031|
|Forward Discount (28/05/21)||-0.06%||-0.02%||-0.21%||-0.29%||-0.45%||-0.90%|
|Forward Discount (23/04/20)||-0.68%||-0.22%||-0.18%||-5.18%||-0.15%||-1.74%|
|Likelihood of Devaluation||Very Low||Very Low||Very Low||Low||Low||Very Low|
*as of 2019
We have outlined below the rationale for our assigned evaluation likelihoods for each of the six currencies in the GCC. We have also included our latest forecasts for both the Egyptian pound and Turkish lira, two nations that have close ties with the economies in the GCC.
Saudi Arabian Riyal (SAR)
Saudia Arabia is one of the world’s largest oil producers. The sharp downturn experienced in oil prices at the beginning of the COVID-19 crisis was, therefore, particularly bad news for the heavily oil-reliant Saudi economy.
Oil revenues account for around 75% of Saudi Arabia’s total export revenue and 40% of overall output. The country’s oil revenues unsurprisingly declined sharply in 2020, contributing to the record contraction in economic activity experienced in the country in Q2 of last year. Activity rebounded in the second half of the year as virus restrictions were eased and oil prices picked up. Saudi Arabia has done remarkably well in suppressing rates of virus contagion following the initial peak in June last year. The country is also so far making steady progress towards building up immunity levels through vaccinations, having now administered more than 40 doses per 100 people at the time of writing. This provides reason for optimism that we’ll see a return to near-normal economic capacity in Saudi Arabia later in the year.
Despite the aforementioned rebound late-last year, real oil GDP still ended 2020 6.7% lower than where it began the year. This downturn in oil revenues plunged the economy deep into recession and has accelerated the need to diversify away from oil production. GDP fell by another 0.1% quarter-on-quarter in Q1, leading to the seventh consecutive quarter of negative annual growth (-3.3%). Oil GDP collapsed by 12% YoY in the first quarter, in large part a result of production cuts by the OPEC countries since May 2020.
The rebound in global oil prices has, however, significantly lessened pressure on the USD/SAR peg, which came under unwanted speculative pressure in mid-2020 at the height of the downturn. Brent crude oil prices increased to $70 a barrel in May, just shy of its highest level…
Read More: Gulf Currencies Market Update – June 2021 – Ebury UK