Goldman says Saudi peg ‘here to stay,’ though at cost to economy

By Paul Abelsky

Saudi Arabia is sacrificing non-oil economic growth with fiscal policies designed to ensure its currency peg’s stability during a period of low crude prices, according to Goldman Sachs Group Inc.

“Maintaining the riyal peg at current levels remains a key policy priority for the Saudi authorities,” Farouk Soussa, a London-based analyst at Goldman, said in a report to clients. “In a low oil price environment, however, this means that fiscal policy will have to tighten, keeping the budget deficit in check in order to ensure that external balances remain consistent with peg stability.”

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Saudi Arabia tethers its currency to the dollar and tends to move in lockstep with the U.S. Federal Reserve. Although pressure intensified earlier this year with the collapse in crude prices, 12-month dollar-forwards for the Saudi riyal have since stabilized.

Goldman said the government’s fiscal plans will likely help the current account return to surplus next year and ensure that in the medium term foreign-exchange reserves steady at slightly over 80% of the narrow money measure, M1.

But “the sharp decline in projected expenditure penciled in over the next three years will depress non-oil economic growth,” Soussa said, forecasting it will average 1.2% year-on-year during that period, compared with trend growth of 2.5%.

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“This will result in a widening gap with the pre-Covid trend level of non-oil economic output,” Soussa said.

The need for fiscal consolidation will make it more difficult to grow the non-oil private sector and achieve Saudi Arabia’s goals of diversifying the economy and boosting employment under Crown Prince Mohammed bin Salman’s development plan known as “Vision 2030.”

Goldman estimates that while around 400,000 Saudis come of working age each year, the average rate of job creation in the private sector over the past 15 years has been about half of that.

The country’s sovereign wealth fund “is not yet fully financially independent of the government, requiring capital injections from government reserves in order to execute its investment plans.”

Higher oil prices would improve the outlook by allowing the government to increase spending without compromising external balances.

Saudi budget projections assume oil prices of around $50 per barrel over the next three years, according to Goldman Sachs.

Three key areas for structural reforms in Saudi Arabia are improving the business environment, promoting foreign direct investment and increasing labor market efficiency

“As Vision 2030 spells out in detail, growing and diversifying the economy and increasing employment will require sustained efforts on the reform front in parallel with government investment,” Soussa said. “In a low oil price environment, where spending is constrained, this becomes even more the case.”