For those anxious for the next “Game of Thrones” episode, there is plenty of drama to be found from another source: crude oil prices. There has been plenty of excitement to be had by following the ups and downs of crude oil prices and the countries whose fortunes follow those prices. And no country in the world is perhaps more closely associated with the price of crude oil than Saudi Arabia. Because of the decline in the price of crude oil, the country has seen its currency under pressure in recent months.
The Riyal’s Peg, For Better or Worse
The Saudi Arabian Riyal, the country’s official currency, has been, in practice, “pegged” to the U.S. Dollar for three decades (at a rate of one U.S. Dollar to 3.75 Saudi Arabian Riyals). This peg, which causes the value of the Riyal to climb or fall in lock-step with the Dollar, has come under intense pressure this year as the key driver of Saudi Arabia’s economy, the price of crude oil, has seen dramatic drops in value.1 The precipitous drop in the price of crude has resulted in a slowing of revenue being realized by Saudi Arabia, and has spawned speculation that Saudi Arabia might allow the Riyal to “float” against the U.S. Dollar, meaning the foreign exchange rate of the Riyal would be variable.2 The drop in oil prices (reaching some of the lowest prices in nearly 15 years) is causing Saudi Arabia to see a dramatic decrease in the inflow of money into the country, leading the government to dip into its currency reserves, and implement austerity measures, to help make up for the shortfall in revenues. Short term, this might be effective; but as oil prices continue to remain low, the Saudi government may face greater pressure prop up its currency as its reserves dwindle. The Saudi government has been working diligently to help support the Riyal foreign exchange rate, with the introduction of a value-added tax, and substantial cuts to spending, including cuts to the enormous subsidies that the populace has become accustomed to.3
When the Levee Breaks...
So what if the Riyal comes unpegged from the Dollar and is allowed to float? The primary problem is that a pegged currency is like a dam holding back a flood: the longer the dam (the peg) is in place, the greater the pressure being held in check is allowed to build up. While a river that is not dammed might sometimes see cyclical ups and downs, as rainy seasons come and go, there is rarely a sudden and catastrophic flood, such as when a dam bursts. In similar fashion, when a currency is allowed to float in relation to other currencies in the foreign exchange market, its foreign exchange rate might move up and down as its value changes in relation to other currencies. But, these changes are gradual, unlike when a pegged currency, who’s foreign exchange rate has been unnaturally forced to stay in lock-step with another currency, is suddenly allowed to float and its foreign exchange rate suddenly (and sometimes dramatically) adjusts in the market to its actual value.
This sudden shock to the foreign exchange rate can have serious repercussions in a country’s economy, as suddenly the prices of goods and services have to adjust as well, in reflection of the currency’s new value. There are countries that have endured this economic shock, and are even today struggling to recover. Argentina, for example, pegged its currency to a fixed foreign exchange rate to the U.S. Dollar. Late in 2001, the currency was allowed to float, causing financial upheaval in Argentina (and played a part in the resignation of President de la Rùa).4 While Argentina had other underlying issues which exacerbated its currency problems, any time a currency is allowed to float it can result in serious economic impacts. These impacts can reverberate through other countries’ economies, as well, who conduct business with the country whose currency is allowed to float.
While the increasing pressure on the Riyal is certainly dramatic, it is not cause for panic. Most currency transfer services offer timely, efficient currency transfers and exchanges, to allow business to allocate their funds wherever in the world is most appropriate—often helping to avoid unnecessary drama.