A fixed ratio between the local currency and another nation’s currency is known as the fixed exchange rate and is used in Saudi Arabia. When an unstable economy is experiencing internal crises, a pegged exchange rate is the most advantageous option since it gives people a chance to predict the situation and guarantees reduced inflation rates. Countries with fixed exchange rates tend to be export-oriented because this enables them to maintain a high level of domestically produced goods’ competitiveness in global markets. The Saudi Riyal appreciates in tandem with the dollar, lowering the price of Saudi imports. Saudi Arabia should reevaluate its pegged exchange rate due to the political system’s unpredictability, which impacts the state of many countries economies and has a very detrimental impact on the local economy.
Pegged exchange rates have benefits and drawbacks, and comprehending this requires a thorough analysis. The drawbacks are that when Saudi Arabia cuts oil prices, customers directly feel the effects of these interlocking swings in oil prices because they influence the cost of commodities globally. There is also a global disadvantage, such as the impossibility of conducting an independent monetary policy, since all state actions aim to maintain the announced exchange rate level. An increase in the value of a foreign currency could raise hopes for further increases so that people may hold or purchase extra foreign currency for speculative motives in their portfolios. As a result, there might be less demand for local money, and one could attribute this relationship to a substitution effect or an expectation hypothesis (Mahmood & Alkhateeb, 2018). A fixed exchange rate raises the possibility of significant losses in state foreign exchange reserves.
In Saudi Arabia, the fixed exchange rate benefits the nation’s economy significantly and has a negative effect. The most significant advantage is the reliability and predictability of fixed exchange rates. As a result, Saudi Arabia can develop long-term strategies which enhance the amount of international commerce and interest rates. Fixed exchange rates have three main goals: to secure the exchange rate, achieve price stability, and manage inflation. As a result, Saudi Arabia pegged its currency to the US dollar, stabilizing the exchange rate and cutting the costs of oil trade transactions, significantly impacting the economy (Althibani et al., 2020). When stable, a fixed exchange rate gives businesses a reliable foundation for planning and pricing, promoting investment and global trade. Since currency fluctuations can negatively impact the state of the economy and future growth prospects, nations with fixed exchange rates likewise protect their economies.
The trend in the GDP of most developing countries’ economies is highly associated with changes in oil prices. When there is an outflow of capital, the nation’s GDP is linked to business activity and efficiency decline. The economic growth of developing nations with economies based primarily on oil exports, such as Saudi Arabia, is negatively impacted by the drop in oil prices to a greater extent. Mohammed Suliman & Abid (2020) stated that Saudi Arabia’s foreign trade depends on oil revenues, which account for 72% of the country’s total exports, 50.4% of GDP, and nearly 70% of government revenue. The status of Saudi Arabia’s economy is severely harmed by sudden changes in the price of oil.
Despite having accumulated substantial foreign savings and assets, Saudi Arabia is being forced by low oil prices to alter its economic strategy, cut spending, and impose new taxes and fees. The oil industry, mostly comprised of oil extraction activities, accounts for 45% of GDP, while services account for 50% of GDP, 90% of total exports, and 80% of government revenue comes from oil sales (Jawadi & Ftiti, 2019). Potential global threats and the future volatility of oil prices make it necessary for the Saudi Arabia authorities to continue diversifying the economy and creating jobs for the expanding workforce in the kingdom.
Oil price is one of the critical indications of Saudi Arabia’s economy and the global economy. Price increases cause financial flows to be redistributed and alter international trade. Countries affect their economies depending on how much the national budget is spent on oil. The rise in oil prices also impacts the shift in the trade balance, exchange, and interest rates. The unprecedently high rise in oil revenue gives room to boost investment. However, there have not been many opportunities for investment in the manufacturing sector in the nations that produce oil (Haque & Imran, 2020). The impact on the nation’s macroeconomics will be more significant the longer this crisis continues, and oil prices rise.
To sum up, Saudi Arabia’s fixed exchange rate promotes investment and helps ensure the economy’s stability. Additionally, it enables the population’s purchasing power to remain stable and allows for inflation control. However, such a practice might have short-term effects, but as Saudi Arabia’s experience demonstrates, it will have serious long-term effects on inflation and trade balance. In addition, a policy like this produces an artificial exchange rate that does not reflect the market’s supply and demand dynamics. Its upkeep necessitates ongoing government intervention, which calls for sizable gold and foreign exchange reserves. The government in Saudi Arabia was unable to maintain the value of the national currency when it ran out, which had detrimental effects on the country’s economy.
Althibani, D., Akeel, H., & Atef, M. (2020). Investigating the possibility of changing the Saudi Arabian Riyal exchange rate regime. Humanities and Social Sciences Letters, 8(1), 46–61.
Haque, M. I., & Imran, M. (2020). Oil prices and terms of trade of Saudi Arabia: An empirical analysis. The Journal of Asian Finance. Economics and Business, 7(9), 201-208.
Jawadi, F., & Ftiti, Z. (2019). Oil price collapse and challenges to economic transformation of Saudi Arabia: A time-series analysis. Energy Economics, 80, 12-19.
Mahmood, H., & Alkhateeb, T. T. Y. (2018). Asymmetrical effects of real exchange rate on the money demand in Saudi Arabia: A non-linear ARDL approach. PloS one, 13(11), 1-12.
Mohammed Suliman, T. H., & Abid, M. (2020). The impacts of oil price on exchange rates: Evidence from Saudi Arabia. Energy Exploration & Exploitation, 38(5), 2037-2058.