Dubai: Saudi Arabia's dollar-pegged riyal surged to a 21-year high against the US currency last week after the world's largest oil exporter said it would hold back from matching a US interest rate cut.
Speculation the kingdom may ditch its peg to the dollar has fuelled a frenzy of riyal buying which has pushed the currency's spot rate to 3.7405 Saudi riyals, the highest since December 1986, according to Reuters data. Bids have touched 3.74 riyals per dollar, a breach of which should trigger central bank intervention.
Saudi Central Bank Governor Hamad Saud Al Sayyari said last week that the kingdom would hold back from cutting interest rates, even after the US Federal Reserve slashed its benchmark rate by 50 basis points to 4.75 per cent.
Possible peg break
"The main story has been the possible break of the peg with the Saudi riyal," said Adam Cole, global head of FX currency strategy at Royal Bank of Canada. "This could lead to lack of confidence in the dollar as its role as a reserve currency is being put into question, which is also supporting the euro."
Saudi Arabia has pegged its currency to the dollar at the same value since 1986 and has rarely moved out of step with US interest rate movements.
"You are going to see pressure on the riyal to take advantage of the policy rate differential," said Caroline Grady, Middle East economist at Deutsche Bank.
Benchmark repo rate
Saudi Arabia's benchmark repo rate is 5.5 per cent and the 75 basis-point spread with the US Fed funds rate creates a positive carry on a long riyal position. It compares with an average 36 basis-point spread in the last 15 years, Grady said.
"Most of the action we are seeing on the forex market, if not all of it, is by European banks," said a treasury manager at a Riyadh-based lender, who declined to be identified. "They are speculating on a revaluation of the riyal, which is not really likely to happen."
Central Bank governor Sayyari has repeatedly ruled out revaluation, saying inflation at a seven-year high is mostly due to domestic factors such as rents rather than higher import costs.
Markets are now waiting to see what the central bank does. "If the spot breaches 3.74 riyals and there is no intervention from the central bank that will mean they will have allowed a revaluation," said Koceila Maames, econ-omist at Calyon in Paris. "But I think they will intervene."
Maames believes de-pegging the riyal from the dollar to a currency basket as Kuwait has done, is possible in the future but said: "The Saudi central bank is credible enough to conduct any change in the FX regime in an orderly way. It won't do it under market pressure," he added.
Saudi Arabia, the UAE and four other Gulf Arab oil producers pegged their currencies to the dollar in 2003 with a view to introducing a single currency in 2010. In May, Kuwait broke ranks, dropping the peg and allowing its currency to appreciate, citing the need to tackle inflation.