Saudis told to prop up currency amid global devaluation war fears

Saudi Arabia should use its massive foreign exchange reserves to defend the riyal, amid fears the world is descending into a new phase of global currency wars, the World Bank has said.

The kingdom’s shaky currency peg with the dollar has come under record pressure this week as the price of oil has plummeted to near 12-year lows at $32-a-barrel.

With the global stock markets in turmoil, analysts fear a Saudi devaluation could spark a new wave of deflation and competitive “beggar-thy-neighbour” policies in a fragile global economy.

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But the world’s largest crude producer should continue to defend its exchange rate by drawing down on its war chest of reserves, according to Franziksa Ohnsorge, lead economist at the World Bank.

“For now they have large reserves, and reserves can be used during an adjustment period”, Ms Ohnsorge told The Telegraph.

Oil accounts for more than three-quarters of Saudi Arabia’s government revenues. But a record supply glut has led to the kingdom burning through its reserves at a record pace in order to defend its 30-year-old exchange rate regime.

Central bank reserves have dropped from a peak of $735bn to around $635bn this year - a pace of spending which will exhaust the kingdom’s fiscal buffers within five years, Bank of America Merrill Lynch calculate.

A fresh round of conflict with rivals Iran and a sustained low oil price world would reduce this cushion substantially, said David Hauner at BaML.

The monarchy has vowed to stick by the exchange regime and is instead planning to strengthen its coffers through the unprecedented flotation of its state-owned oil giant, Aramco.

Concerns about the Saudi peg come as fears that China was engineering on its own covert currency devaluation rippled through global markets this week.

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The S&P 500 endured its worst start to a year since 1928, while European equities suffered their biggest opening year losses for over 45 years. More than £85bn was also wiped off the FTSE 100 in a torrid start to 2016 trading.

Investment bank Goldman Sachs has warned Beijing may soon abandon its support for the renminbi and engineer a full-blown devaluation.

“Just as the US and European phases of the financial crisis were eventually curtailed by currency devaluation and quantitative easing, the fear is that emerging market economies and even China might need to do the same”, said Peter Oppenheimer at Goldman.

Faced with declining revenues, the Saudi monarchy has been forced to unveil a radical programme of government austerity to compensate for the 70pc decline in Brent prices over the last 18 months.

Markets are now betting the kingdom will have to abandon its exchange rate regime - which has fixed the riyal at 3.75 to the dollar since 1986.

Forward contracts for the riyal have soared to their highest levels in nearly 20 years - a sign that investors no longer believe in the viability of the peg.

However, Ms Ohnsorge said plans for fiscal consolidation gave the kingdom room to carry on defending the riyal in order to limit the pain on its oil-reliant economy.

“Saudi Arabia can smooth the adjustment to a future of lower commodity prices, which by our estimates will be low for a long time” said Ms Ohnsorge.

The World Bank expects global commodity prices will not return to their post-financial crisis peaks until the next decade, while oil will average around $49-per-barrel in 2016.

Currency pegs allows nations to keep inflation and export prices stable. But the commodities crash has already swept away currency controls in Kazakhstan and Russia who have both abandoned their exchange rate pegs in recent months.

Ms Ohnsorge said the Saudi Arabia remained one world's "luckiest" oil exporters on account of its relatively large foreign reserves.

"Any option is difficult. Having fiscal adjustment is difficult and having an exchange rate depreciation is difficult. It's not like there is one which is an easier way out", she said.