Critical Thinking_Saudi Arabia Currency and the U.S. Dollar

Saudi Arabia’s Currency and the U.S. Dollar

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Saudi Arabia’s Currency and the U.S. Dollar

Introduction

Saudi Arabia has 18% of the world’s proven petroleum oil reserves. It is the largest exporter of petroleum in the world. The oil and gas sector represents 50% of the GDP of Saudi Arabia and 70% of the export earnings of the country. The share government revenues on oil increased to 74% in the aftermath of the 1973 oil crisis (Al Rasasi & Banafea, 2015). It has remained high since then. Therefore, the oil and gas sector is the cornerstone of the Saudi Arabian economy.

Saudi Arabian Riyal and the U.S. Dollar

The Saudi Riyal, just the currencies of other gulf countries, is pegged on the U.S. dollar. Being pegged on the dollar is associated with several benefits. It makes it easy for the country to manage its exchange rate policy in relation to other currencies in the world. Relevant authorities determine the exchange rate of the Riyal in dollars, which helps in determining the exchange rate of the currency to other currencies in the world. Pegging the Riyal to the dollar also protect the economy of Saudi Arabia from inflation since the economy is linked to the monetary policy of the U.S.

Impact of Oil Prices on Saudi Arabia

Saudi Arabia has experienced several economic situations in the past few decades. High oil prices have supported the economic growth of the country. Being dependent on oil revenues has also had a negative impact on the Saudi Arabian economy. For instance, a sharp decline in oil prices between 1981 and 1985 exposed the country to economic turmoil. The decrease in price of oil led to a 52% reduction in government expenditure during this period. The reduction in capital expenditure by the government, which attracts investors to the country, had a negative impact on the long-term economic outlook of the country. The turn of the century can be regarded as the golden years of oil. Prior to the 2008 financial crisis, the price of oil increased significantly. It increased from $23 in 2002 to a high of $149 in 2008 just before the global financial crisis. It reduced during the global financial crisis before increasing again after the end of the financial crisis. Oil revenues have provided the government with funds to invest in several infrastructural projects (Al Rasasi & Banafea, 2015). The government acknowledges that oil is a non-renewable resource. Therefore, the revenues are bound to stop in the future. This is the main reason as to why the government of Saudi Arabia focuses on diversifying the economy to reduce overreliance on oil revenues.

Impact of Dramatically Declining World Oil Prices

Dramatic decrease in the world oil prices would lead to a decrease in the government revenues since oil is the major source of government revenues. Since oil is the major source of foreign exchange into the country, a decrease in the demand would lead to a reduction in the foreign exchange reserves of the country. This may lead to an increase in value of the dollar in relation to the Riyal since there would be a higher demand for U.S. dollars to import various products. The decrease in the value of the Riyal in the international market would subsequently lead to an increase in the price of imports. This would subsequently lead to inflation since Saudi Arabia depends is highly dependent on importation to access various goods and services. However, the increase in the price of imported products can increase the competitiveness of domestic products. The reduction in the prices of oil would lead to the reduction of government revenues and spending. This would have a negative impact on other sectors of the economy such as real estate sector especially projects that rely on government spending. It would also have a negative impact on the banking and financial sector. This is because most banks depend on the financial surpluses and revenues of the government. A reduction in the price of oil would lead to a significant reduction in the government spending, which would subsequently lead to reduced liquidity in the economy (Carbaugh, 2019). The government can tackle this situation by reducing interest rates. This would increase money supply in the economy. The reduction in the world oil price would also have a negative impact on the balance of payment of Saudi Arabia. It would decrease the value of exports while increasing the value of imports (Pugel, 2016). This would reduce the balance of payment surplus of Saudi Arabia.

Impact of Dramatically Increasing World Oil Price on Saudi Arabian Riyal

A dramatic increase oil prices would lead to an increase in the value of the Riyal in the international market. This is because the increase would lead to an increase in the demand for the Riyal by countries that purchase oil in the international market. The dramatic increase in the price of oil would also lead to an increase in aggregate demand. It would provide the government with higher revenues, which it can invest in various projects. Increased government spending would lead to an increase in aggregate demand Al Rasasi & Banafea, 2015). This would lead to inflation since it would increase money supply in the economy. This would necessitate the government to increase the interest rates to mop up the excess money supply in the economy (Duran, 2016). An increase in the international price of oil would also have a positive impact on the balance of payment of Saudi Arabia since it would increase the value of exports and reduce the value of imports.

This was evident in the period 2007-2008 when the prices of oil in the world market increased. It led to an increase in government spending in the subsequent years. In 2007, government spending was 61,756 million Riyals. It increased to 63,031 million, 79,148 million, and 92,017 million Riyals in 2008, 2009, and 2010 respectively (Al Rasasi & Banafea, 2015). The increase government spending led to an increase in industrial production in Saudi Arabia. The increase in the value of the Riyal in the international market reduced the competitiveness of Saudi Arabian exports in the global market (Al Rasasi & Banafea, 2015).

Conclusion

Saudi Arabia’s economic development is highly linked to oil. Therefore, changes in the price of oil in the international market would lead to economic shocks that would have a negative impact on the economy. This is one of the main reasons as to why the government has developed a plan that would facilitate the diversification of the economy and reduce dependence on oil. This plan is outlined in Vision 2030. The actualization of the vision would lead to economic transformation of the country and provide a foundation for future economic prosperity.

References

Al Rasasi, M., & Banafea, W. A. (2015). The Effects of Oil Shocks on the Saudi Arabian Economy. The Journal of Energy and Development, 41(1/2), 31-45.

Carbaugh, R. J. (2019). International Economics, 19th Edition. Boston, MA: Cengage Learning.

Duran, H. E. (2016). Exchange rate movements and its local effects: Turkey case. International Journal of Economics and Financial Issues, 6(2), 442-449.

Pugel, T. A. (2016). International Economics, 16th Edition. New York, NY: McGraw-Hill Education