The highly volatile global markets as a result of US credit rating downgrade by Standard & Poor's and the escalation of debt problems in the euro zone, which led also to marked drop in the prices of oil, will not have too great an impact on the Saudi economy “as the growth momentum is coming from high government spending that can be afforded comfortably,” Riyadh-based Jadwa Investment said Tuesday. Oil prices remain the main link between the global economy and that of the Kingdom. Recent developments have pulled oil prices down by more than 15 percent in little over a week. Brent dipped below $100 per barrel for the first time since February and WTI hit its lowest level since November 2010. "Nonetheless, prices remain above the $84 per barrel (Saudi export crude) we estimate is necessary to avoid a budget deficit this year. Indeed, the average for the year to date for Saudi export crude is comfortably in excess of $100 per barrel," it said. Further signs of a worsening global economic environment could well push oil prices lower. Should the US fall back into recession, it would be a more normal recession than in 2008, meaning the movement in oil prices would be much less severe. Rather than the spectacular drop in the second half of 2008, from almost $150 per barrel to just over $30 per barrel, prices could drop to between $50 and $60 per barrel. Even in this scenario, "we do not think there would be much impact on Saudi government spending. Rather, the government would draw down its foreign assets to finance the spending, as it did in 2009. SAMA net foreign assets were $492 billion at the end of June, $49 billion above their 2008 peak." Jadwa believes that US government bonds constitute the bulk of SAMA's net foreign assets. SAMA has publicly referred to three criteria it uses to manage its portfolio of reserves: safety, liquidity and long-term returns. The downgrade has clearly called into question the first of these criteria. Nonetheless, no market outside the US offers the same level of liquidity, or the same array of financial instruments, so while SAMA will closely monitor the situation, we do not expect a major change in its asset allocation policy. The downgrade is negative for the dollar and therefore the riyal, but it should not trigger a significant short-term fall, Jadwa noted. Jadwa also said the downgrade will have an impact on the exchange rate peg between the riyal and the dollar. A fall in the dollar will add to inflationary pressures in the Kingdom. In 2010, 46 percent of the Kingdom's imports were from emerging markets, and these currencies are likely to climb the most against the dollar. At the moment, the peg makes sense for the Kingdom for economic reasons including the reliance on dollar-denominated oil revenues and the potential damage to non-oil competitiveness and foreign investment any adjustment would cause. In addition, it is backed by a strong strategic commitment. “We think it would take a serious decline in the dollar sustained over several years for there to be any reconsideration of the peg,” Jadwa said. Moreover, the Saudi stock market has followed global markets in selling off sharply. "Further volatility driven by moves on global markets is likely and sharp falls cannot be discounted," Jadwa said. In this environment of heightened uncertainty and a volatile stock market that is closely linked to global markets, "the real economy offers an attractive option for Saudi investors," Jadwa stressed. "The government has the financial resources and publicly made the commitment to huge investment spending, particularly in housing," it added.
