Introduction
Saudi Arabia’s economy is heavily reliant on money from oil exports. Therefore, global oil price fluctuations may considerably influence the country’s economy. Since the Riyal is tied to the US dollar, the nation must keep massive foreign reserves in order to maintain stable exchange rates. As a result, variations in the value of the US dollar may have a significant impact on the Saudi economy. The vast foreign reserves aid in regulating global oil prices’ cyclical swings to minimize adverse economic consequences. Oil price increases and decreases can benefit or negatively impact the country’s economy through factors such as the Gross Domestic Product (GDP), interest rates, inflation, and trade balance.
Advantages and Disadvantages of the Pegged Exchange Rate
The main advantage of a fixed exchange rate is that it reduces currency volatility. Currency fluctuations are natural in every economic system, but they can have an impact on commerce when they become severe. This necessitates the use of a cap to control the oscillations. For example, if a European country sends its products to the United States at a time when the pound is fast rising, the exports would be uncompetitive (Yu et al., 2018). This increases the likelihood of the firm collapsing and departing the market.
Disadvantages
While a set currency rate can keep inflation under control, its rigidity is its downfall. Once a government adopts this approach, it becomes difficult to respond efficiently to market financial turmoil. This creates difficult conditions for investors, particularly when faced with a balance of payments deficit and little prospect of devaluation. Another disadvantage is the possibility of entering the system at the incorrect rate limit (Yu et al., 2018). If the rate is excessively high, a country’s exports will be less competitive, and some firms will be forced out of the market.
Gross Domestic Product
An oil price increase causes the country’s GDP to rise. When prices rise, a fixed volume of oil exports will result in a comparatively higher income. As a result, Saudi Arabia gets more foreign cash, and exchange rates favor the Riyal. Saudis will have more money to spend on international financial products. A rise in oil prices benefits the Saudi currency and stock markets since it leads to higher income. Nonetheless, additional variables may influence the local currency’s strength versus international currencies.
Declining oil prices cause the Saudi Riyal to depreciate in value as shown in figure 1. Export income influences foreign exchange rates (Mohanty et al., 2018). Since Saudi Arabia is heavily reliant on oil exports, a drop in oil prices has a negative impact on the economy. A drop in oil prices might have a substantial impact; according to research from the Federal Reserve Bank of Dallas, if oil prices fell by $1, Saudi Arabia’s earnings from oil exports would fall by $2.5 billion each year (Mohanty et al., 2018). A restricted amount of disposable dollars will be available to purchase foreign currency or financial products.
Interest Rates
The Saudi Arabian Monetary Authority (SAMA) regulates interest rates in the country, considering factors such as foreign commerce and the intended level of macroeconomic activity. An increase in the country’s interest rates increases demand for the Riyal and causes its value to rise. Consequently, a drop in interest rates reduces demand for the Riyal, causing it to depreciate (Carbaugh, 2019). According to Carbaugh, (2019), “higher interest rates make the country’s exports, especially oil, more expensive” (p. 424). As a result, when the price is the only concern, demand for the product may fall. If rising oil prices cause inflation, the government may respond by raising interest rates to stabilize the Riyal’s value.
When oil prices fall, the quantity of income generated by the oil trade falls. The government’s reaction to altering interest rates may be influenced by a number of variables, including the economic situation caused by the drop in oil prices (Carbaugh, 2019). If falling oil prices induce an economic downturn, interest rates may be decreased in order to enhance the availability of cash required to boost investment. A rise in interest rates can assist in reducing spending patterns and cash outflows to foreign nations via import purchases. As a result, the decision to raise or lower interest rates is influenced by the present or desired economic state.
Inflation
Increased government expenditure follows an increase in revenue as a result of rising oil prices. For instance, greater government expenditure was a result of a rise in oil prices from 2007 to 2008. Government spending in 2007 totaled 61 756 million Riyals; however, in the three years that followed, this amount dramatically grew (Aloui et al., 2018). The government spent 63,311,79,148, and 92,017,000,000 Riyals in each of the years 2008, 2009, and 2010 (Aloui et al., 2018). Inflation rises as a result of increased government expenditure since it expands the available cash in the economy as shown in figure 2. In order to reduce inflation, efforts must be taken, notwithstanding any potential gains from rising oil prices.
A significant drop in the price of oil might trigger an economic downturn. The government and consumers have greater purchasing power with increased cash from oil exports. If revenues fall dramatically, demand for locally produced items and imported goods falls, potentially leading to inflation or recession. However, the Saudi government has been utilizing foreign reserves to avoid negative economic conditions (Aloui et al., 2018). Low oil prices have a negative impact on the economy, making it necessary for governments to adopt steps to avert an economic catastrophe.
Trade Issues
Fluctuations in the oil price may have an influence on the trade conditions set by oil-exporting countries. Positive trade terms may result in increased GDP and investment in oil-producing and exporting nations (Al Rasasi et al., 2019). High oil prices suggest that more wealth is moved from oil-importing nations to oil-exporting countries, enhancing the possibility for economic investment by corporate entities in oil-exporting countries (Al Rasasi et al., 2019). As a result, rising oil prices will encourage greater investment and trade in the oil sector.
A drop in oil prices might have a negative impact on Saudi commerce. Commerce policies developed in reaction to oil price changes may affect local and global trade. Countries with weakening currencies may opt to establish trade restrictions (Carbaugh, 2019). According to Carbaugh (2019), “restriction of trade helps to boost the local currency if its value has fallen due to oil price volatility” (p. 470). For example, Saudi Arabia can limit oil supplies if the Riyal declines in value, resulting in more demand and higher oil prices.
Conclusion
Since the global oil price continues to fluctuate, governments should establish suitable policies to optimize the advantages while mitigating the risks. When oil prices rise, the exporting country’s income rises, and the currency’s value rises. However, the country’s currency may weaken if prices fall drastically due to poor trading conditions. Interest rates are significant tools for regulating a nation’s economic activities. Following a significant movement in global oil prices, consideration should be given to the present and desired economic states before increasing or cutting interest rates. Thus, oil price increases provide large income, making governments raise their spending.
References
Aloui, C., Hkiri, B., Hammoudeh, S., & Shahbaz, M. (2018). A multiple and partial wavelet analysis of the oil price, inflation, exchange rate, and economic growth nexus in Saudi Arabia. Emerging Markets Finance and Trade, 54(4), 935-956.
Al Rasasi, M., Qualls, J., & Alghamdi, B. (2019). Oil revenues and economic growth in Saudi Arabia. International Journal of Economics and Financial Research, 5(3), 49-55.
Carbaugh, R. (2019). International economics (17th ed.). Cengage Learning.
Mohanty, S. K., Onochie, J., & Alshehri, A. F. (2018). Asymmetric effects of oil shocks on stock market returns in Saudi Arabia: Evidence from industry level analysis. Review of Quantitative Finance and Accounting, 51(3), 595-619.
Yu, K. H., & Hui, E. C. M. (2018). Housing market dynamics under a pegged exchange rate–a study of Hong Kong. International Journal of Strategic Property Management, 22(2), 93-109.