Peninsula - 18/5/2006

Saudi Arabia has inspired intense market speculation about a possible revaluation of its riyal, but investors betting on an immediate shift in the currency's dollar peg are likely to be proven wrong.

Investors began piling into riyal forwards six weeks ago when it became clear the Saudi Arabian Monetary Agency (SAMA) was not going to match a March interest rate hike by the US Federal Reserve, something it has routinely done in the past.

Then Kuwait allowed its dinar to appreciate against the dollar last week, prompting investors to bet that a falling US currency would prompt other countries in the world's biggest oil exporting region to follow suit.

SAMA issued a statement last week ruling out a revaluation, but its failure to match last week's quarter point Fed hike is fuelling talk that a growing divergence with US policy will force the Saudis to tweak their currency peg.

With any change expected to lead to an appreciation of the riyal, the currency of the world's biggest oil exporter, riyal swaps were pointing a rise against the dollar yesterday, but most analysts say markets may have got it wrong. "We do not believe SAMA will allow the riyal to revalue in the near-term," said Steve Brice, regional head of research at Standard Chartered Bank in Dubai.


LESS FLEXIBLE

Any speculation based on Kuwait's revaluation was simply unfounded, he said. Kuwait has adjusted its currency peg before – the last time was 17 months ago – and maintains the dinar in a trading band.

Saudi Arabia, like the other Gulf Arab states, runs a much less flexible currency regime.

"If SAMA is to choose between an interest rate hike and revaluation, it will opt for rates. Riyal stability has been a cornerstone of Saudi monetary policy since the mid-1980s." said Zahid Khan, chief economist of Riyad Bank.

Saudi Arabia, easily the largest economy in the Gulf, has also championed currency stability in the runup to regional monetary union in 2010. A sudden Saudi revaluation could deal a body blow to plans for integration.

"As we head towards the single currency, abnormal moves - remember Kuwait's move was not unexpected - may be deemed potentially damaging to the whole project," said Brice.

Saudi Arabia also has more pressing concerns these days than the dollar's fall against major currencies-cited by Kuwait's finance minister as a major reason for its revaluation.