Introduction
Saudi Arabia, a significant participant in the global oil market, is confronted with a dual economic environment driven by its petroleum industry and a fixed exchange rate connected to the US dollar. This paper aims to examine the benefits and drawbacks of this fixed exchange rate, as well as the ramifications for the Saudi economy. Furthermore, it digs into the deep dynamics by examining the effects of varying global oil prices on key economic indicators such as GDP, interest rates, inflation, and trade balance.
Understanding the repercussions of such fluctuations in a nation integrally linked to the petroleum industry is essential for strategic economic planning in a world where oil prices may be erratic. While the Saudi fixed exchange rate ensures stability, it limits monetary policy flexibility; considering the impact of shifting oil prices exposes a delicate balance between oil dependency and the need for economic diversification.
Advantages and Disadvantages of a Pegged Exchange Rate
Saudi Arabia’s fixed exchange rate has advantages and disadvantages that substantially impact its economic environment. One noteworthy advantage is the pegged rate’s stability and predictability (Razek & McQuinn, 2021). By pegging its currency to the US dollar, Saudi Arabia creates a feeling of security in the foreign exchange market, decreasing uncertainty for companies and investors. This stability is important for long-term economic planning since it fosters an atmosphere that encourages investment and growth.
Another benefit is trade facilitation since a fixed currency rate minimizes exchange rate risk, making international trade transactions easier for Saudi enterprises. Firms engaged in cross-border commerce can better plan and manage their financial responsibilities with a stable exchange rate, resulting in smoother international economic interactions (Razek & McQuinn, 2021). Furthermore, a fixed exchange rate can aid inflation control by anchoring expectations about the currency’s value, which helps reduce inflationary pressures. This consistency in currency value offers a framework for monetary authorities to undertake measures that reduce inflation, guaranteeing domestic price stability.
The pegged exchange rate structure, on the other hand, has its drawbacks. The loss of monetary independence is a key disadvantage of a pegged exchange rate regime (Goczek & Mycielska, 2019). Saudi Arabia loses its capacity to pursue autonomous monetary policy in a pegged system. The country must match its interest rates with those of the United States, restricting its ability to respond to domestic economic situations through interest rate adjustments.
Furthermore, a fixed currency rate arrangement makes the economy sensitive to foreign shocks. The inability to independently regulate interest rates or change monetary policy makes mitigating the consequences of external shocks difficult. Another problem is dealing with the risk of speculative pressures on the currency. According to Goczek and Mycielska (2019), speculative forces can provide difficulties for policymakers as they seek to sustain the peg against external demands. In this instance, during moments of economic uncertainty, the pegged exchange rate may attract speculative activities, resulting in currency volatility.
Impact of Dramatically Declining World Oil Prices
GDP
The immediate impact of substantially falling global oil prices on Saudi Arabia’s GDP is a serious consequence. As a country that is reliant on oil exports, a significant drop in revenue happens when the global oil market falls (Carbaugh, 2019). Oil price declines correspond with decreased income from oil exports, impacting total economic production. A current account deficit may be mitigated by capital and financial flows in the framework of the balance of payments. However, Carbaugh (2019) suggests that relying on foreign funding, as Saudi Arabia may do during a period of lower oil revenue, may bring fragility and expose the economy to volatility in global financial markets.
Furthermore, as a result of decreasing oil income, the likelihood of government expenditure cuts looms. Given the importance of oil income to the government’s budget, a drop in prices necessitates budgetary changes (Carbaugh, 2019). While intended to reduce the fiscal imbalance, these spending cuts have larger repercussions. Government spending cuts may have a negative impact on non-oil industries, thereby impeding their growth and development.
Interest Rates
The fixed exchange rate mechanism exacerbates the difficulties encountered amid a sharp drop in oil prices. With the currency rate tied to the US dollar, the central bank’s capacity to modify interest rates is limited, posing considerable monetary policy issues (Longe et al., 2019). This constraint makes it more difficult to adopt effective monetary policies suited to the unique demands of the domestic economy during economic downturns.
Furthermore, lower government revenue as a result of lower oil prices might lead to increasing external financial pressure (Longe et al., 2019). As the government faces fiscal restrictions, it may become more reliant on foreign money to maintain public expenditure. This reliance on foreign sources adds another layer of risk, exposing the economy to swings in global financial markets.
Inflation
During a gradually decreasing oil prices, a fixed exchange rate may contribute to imported inflation. Import costs may rise if the currency falls in reaction to lower oil earnings (Longe et al., 2019). This situation increases the possibility of imported inflation, which might have an influence on total price levels in the local economy. The effect of lower government expenditure on domestic demand becomes critical. Government spending cuts might contribute to a drop in overall demand in the economy. This decrease in local demand has ramifications for inflation, perhaps worsening the issues created by imported inflation, which is linked with the weakening currency.
Trade Balance
The drop in oil prices hurts Saudi exporters’ ability to compete. Because oil makes up a large portion of Saudi Arabia’s exports, a drop in oil prices might make the country’s exports less competitive overall. One important part of the current account is the trade balance, according to Carbaugh (2019). In this sense, a trade deficit may result from a significant drop in the value of exports, particularly oil exports, due to falling oil prices, which may contribute to a possible current account deficit.
Impact of Dramatically Increasing World Oil Prices
GDP
A rise in oil prices boosts Saudi Arabia’s government revenue, boosting GDP. The increasing revenue from oil exports improves the government’s budgetary capabilities. Carbaugh (2019) emphasizes how oil money, which accounts for a sizable portion of Saudi Arabia’s budget, has a big impact on government finances. Therefore, the inflow of capital works as a stimulant for economic growth, thus contributing to the nation’s GDP growth.
Interest Rates
The increase in government spending may result in inflationary pressures. As per Carbaugh (2019), there is a relationship between rising government expenditure and inflation rates on demand-pull inflation. In this case, when government spending increases, demand for products and services may surpass supply, thus driving up prices. This inflationary pressure demands careful management, including monetary policy adjustments, mainly given the limits of a fixed currency rate.
Inflation
During a period of rising oil prices, the pegged exchange rate regime may help to preserve exchange rate stability. Exchange rate regimes, according to Olayungbo (2019), deliver stability and predictability. A fixed exchange rate guarantees that the Saudi Riyal’s value stays tied to the US Dollar, providing stability even if oil prices rise. This stability is essential for maintaining investor trust and promoting international trade.
Trade Balance
The rise in oil prices may result in a current account surplus as export profits rise. Carbaugh (2019) asserts that changes in export profits have an influence on the balance of payments, stressing how an increase in export income adds to a current account surplus (Olayungbo, 2019). The rise in oil prices raises the entire value of Saudi exports, which might result in a surplus, indicating a good balance between savings and investments in the global economy.
Conclusion
In conclusion, the research focuses on the problems and possibilities associated with Saudi Arabia’s fixed currency rate in the face of unpredictable oil prices. While the peg offers stability, it limits the flexibility of monetary policy. When oil prices fall, the economy suffers from reduced GDP and inflation due to the fixed rate.
Surges in oil prices, on the contrary, provide fiscal benefits, although controlling inflation and export competitiveness is valuable. To negotiate these dynamics, Saudi Arabia should continue to diversify its economy, focusing on non-oil industries, and reconsider the fixed currency rate’s long-term viability. Maintaining monetary policy flexibility provides such benefits as economic resilience in the face of global oil market difficulties.
References
Carbaugh, R. J. (2019). International economics (17th ed.). Cengage.
Goczek, Ł., & Mycielska, D. (2019). Actual monetary policy independence in a small open economy: The Polish perspective. Empirical Economics, 56, 499-522. Web.
Longe, A. E., Muhammad, S., Ajayi, P. I., & Omitogun, O. (2019). Oil price, trade openness, current account balances and the official exchange rate in Nigeria. OPEC Energy Review, 43(4), 446-469. Web.
Olayungbo, D. O. (2019). Effects of global oil price on exchange rate, trade balance, and reserves in Nigeria: A frequency domain causality approach. Journal of Risk and Financial Management, 12(1), 1-14. Web.
Razek, N. H., & McQuinn, B. (2021). Saudi Arabia’s currency misalignment and international competitiveness, accounting for geopolitical risks and the super-contango oil market.Resources Policy, 72. Web.