London — Saudi Arabia’s decision to wage an oil volume war with Russia, which proved badly timed as it coincided with coronavirus lockdowns and tumbling crude demand, exacted a heavy toll on the kingdom’s finances.
Total foreign reserve assets fell by almost $24 billion in March, the largest one-month decline for at least 20 years, according to the latest official data from the kingdom’s central bank, the Saudi Arabian Monetary Authority (SAMA).
Reserve assets had fallen from a peak of $746 billion in August 2014 but until March had been steady at around $500 billion since the middle of 2017 (“Monthly bulletin”, Saudi Arabian Monetary Authority, April 28).
However, total reserves tumbled to just $473 billion at the end of March, the lowest for nine years, in a sign of the strain the volume war and the coronavirus epidemic imposed on the kingdom’s balance of payments.
Reserves have almost certainly fallen even further in April in line with a big drop in oil prices and reduction in export revenues as the volume war and epidemic worsened last month.
Front-month Brent futures prices averaged just $27 per barrel in April, down from $34 in March and $55 in February. So export earnings are likely to have fallen even further.
Accelerated reserve depletion helps explain why the kingdom reached a deal on production cuts with Russia and other members of OPEC+ on April 9, after failing to reach agreement at the previous meeting in Vienna on March 5.
Intense political pressure from the United States undoubtedly played a role, and provided diplomatic cover for the abrupt change in strategy (“Trump told Saudi: Cut oil supply or lose U.S. military support”, Reuters, April 30).
But persisting with unrestricted volume warfare at a time when the epidemic had caused an unprecedented collapse in oil consumption had become financially unsupportable. It had also become all but impossible to find buyers to take more crude.
Some commentators have tried to identify winners and losers from the volume war. The reality is that, once the lockdowns expanded around the globe to curb the coronavirus, Saudi Arabia, Russia and the United States all became losers.
Whatever the wisdom of launching a volume war, the kingdom’s initiative in early March was certainly ill-timed given the accelerating pandemic and persisting with the strategy would have been catastrophic.
Faced with a growing disaster that was wrecking the finances of the Saudi and Russian governments, as well as U.S. shale producers, all sides had been softened up and were ready to agree a face-saving truce by early April.
The unusual steadiness of reserves for over two years between 2017 and early 2020 implies $500 billion had become a formal or informal target for policymakers keen to demonstrate financial strength.
The kingdom maintains a fixed exchange rate between the Saudi riyal and the U.S. dollar, so it needs to maintain a large cushion of reserves to maintain confidence in the peg.
The minimum needed to sustain confidence in the peg is unknown, and perhaps unknowable, but a reasonable estimate is probably $250 billion-$300 billion.
In that context, the sharp drain in March shows volume war and the epidemic had put the kingdom on an unsustainable course that would have started to threaten the peg within a year.
In a statement issued on Monday, intended to reassure currency owners, SAMA said it remained committed to maintaining the fixed rate at 3.75 riyals to the dollar.
“SAMA affirms its commitment to its exchange rate policy of pegging the Saudi riyal to the U.S. dollar as a strategic choice that has supported economic growth in Saudi Arabia for over three decades,” it said.
“SAMA’s foreign exchange reserves remain sufficient to meet all demands of the national economy for foreign exchange, with foreign exchange reserves covering 43 months of imports.”
The modest rise in Brent prices in the last 10 days will ease some pressure on reserves, provided it is sustained, giving the government a strong incentive to make the OPEC+ deal work. Brent, which fell well below $20 a barrel in April, was trading around $30 on Tuesday.
But the kingdom still needs to make deep cuts in government spending and the import bill, as well as increase foreign borrowing.
“We must reduce budget expenditures sharply,” Saudi Finance Minister Mohammed al-Jadaan told Al-Arabiya television on May 2.
“Saudi finances need more discipline and the road ahead is long,” he said, while outlining plans for increased borrowing and a reserve draw down to smooth the adjustment.
Deep budget cuts will make it harder for the government to pursue its programme for social and economic transformation and will make it tougher to shelter the population from the epidemic’s economic fallout.
The coronavirus-driven collapse in global oil consumption will force it to prioritise short-term stabilisation over long-term plans.
Saudi Arabia needs the new OPEC+ deal to raise crude prices quickly, or its choices may become even more stark.