Fiscal and Monetary Policies under the Fixed Exchange Rate in Saudi Arabia

Fiscal and Monetary Policies under the Fixed Exchange Rate in Saudi Arabia

Introduction

Fiscal and monetary policies are critical aspects in any economy. Fiscal policies deal with taxation and various forms of government spending. Government generates revenue through taxation and uses the revenue to develop projects that are supposed to serve the interests of the people. On the other hand, monetary policies deal with the amount of money supply that is present within the economy. It also deals with interest rates and often administered by the central bank of a country. Fiscal policies are administered by various government departments. When delving into fiscal and monetary policies, different exchange rate systems can be used. They include fixed and variable exchange rate. A country that employs a fixed exchange rate is the Kingdom of Saudi Arabia.

Monetary policy in the country is carried out by SAMA also known as the Saudi Arabian Monetary Agency. The country has a fixed exchange rate meaning that the riyal is pegged against the US dollar. The exchange rate has been fixed since 1981 when the SDR/riyal link was suspended. The fixed exchange rate has over time been observed to bring about price stability especially in the balance of payments. The SAMA alters the foreign exchange reserves in a bid to ensure that the fixed exchange rate does not affect the volatility of the financial and economic markets in the country. The system is very different from other countries where the exchange rate is determined by market forces. Several pros and cons are associated with the exchange rate system. This paper assesses some of the impacts that the exchange rate system has on the monetary and fiscal policies in the country.

How the Fixed Exchange Rate increases the Living Standard

The fixed exchange rate system in the country has in the past come under sharp criticism from economists and analysts who suggest that market forces should be allowed to take their course. However, others have differed asserting that the monetary and fiscal policies in the country perform better due to the fixed exchange rate system. Such assertions have often pointed towards increasing the living standard of the people in the country. One of the ways that the fixed exchange rate enhances the living standards of the people is through ensuring price stability. Price stability is a desirable attribute in any economy since it ensures that there are no volatilities which can over time lead to loss of value among the assets that are held by the citizens. Price stability also helps instill confidence in the exchange rate regime in the country.

Such stability is considered by foreign investors who may want to invest in the country. They see it as an incentive since they are assured that their investments cannot be lost when market forces change. Increased domestic investment in Saudi Arabia tends to have a positive impact on the economy (Jareer, 2018). Foreign direct investments increase the number of jobs in the country and this has a direct positive impact since it reduces the resultant unemployment rate in the country. Price stability is also evident through the internal prices of household commodities. When there is price instability, a lot of uncertainty affects the manner in which people in the country purchase products and services. The fixed exchange rate system provides surety for households regardless of the time they require to purchase household items. Such an aspect has great positive impacts on the people in society in the long-term.

The exchange rate system also has positive impacts on the living standard of the people due to ability by the government through SAMA to maintain low inflation. Inflation is not desirable in any economy since it leads to loss of value of the currency and increases the cost of borrowing (Rashid,& Rousane, 2016). Businesses across Saudi Arabia profit a great deal when the level of inflation is maintained at a low. It means that businesses which need to expand can access loan facilities without any fear since they are assured that the inflation rate is low. Low inflation also leads to low interest rates on some of the lending facilities that are available in the country. SAMA promotes economic growth through maintaining low interest rates for businesses and individuals who wish to expand their ventures.

The fixed exchange rate system also helps increase the living standard through helping in the diversification of the economy. The economy of Saudi Arabia has for a long time relied on petroleum products. An oil-based economy is one that faces huge risks and uncertainties due to fluctuations in the global market price of oil or gas. Saudi Vision 2030 was developed to help in the diversification of the economy to reduce the overreliance on oil and other petroleum products. Diversification of the economy is being achieved through the fixed exchange rate. If the system did not exist, there would be very huge volatilities in the market due to changes in global oil prices. The system thereby allows other industries apart from the oil industry to thrive. Such an aspect has created many jobs and created a realization among people that they do not have to work in the oil industry to have a great livelihood.

Goals of the Monetary and Fiscal Policies in Saudi Arabia

The fiscal and monetary policies of Saudi Arabia are focused on several goals in regards to the economy of the country. Since oil export revenues are the main components of the country’s budget, the fiscal policy of the country is geared towards various developments in the industry. However, there has been a push to increase the level of diversification of the economy in the recent past. Fiscal policies have been critical towards pushing for this goal. Various industries have benefited from a wide array of incentives that are included in the fiscal policies of the country. The monetary and fiscal policies have also been geared towards creating stability not only in the short-term but also in the long-term (Al-Hamidy, 2012). It is for this reason that Saudi Arabia has a fixed exchange rate system unlike many nations across the globe.

Before the fixed exchange rate was adopted in the 1980s, volatilities in the oil industry meant that the financial market in the country was highly susceptible to disruptions that are caused by changes in the global oil prices. Sustainable growth cannot happen when the financial markets are highly volatile. Unlike other economies, Saudi Arabia heavily depends on the oil industry regardless of the current diversification that is being pursued (Dibooğlu, & Aleisa, 2014). High revenues from the oil industry are often perceived to be beneficial to the economy. However, they also present huge challenges and it is the role of the fiscal and monetary policies in the country to ensure that such challenges do not affect sustainable growth of the economy. Some of the challenges include inflation, poor distribution of oil revenues, and accumulation of foreign assets by local companies.

When incomes or revenues from the oil industry increases rapidly, there is bound to be runaway inflation. The fixed exchange rate helps maintain the fiscal and monetary policies within a manageable level meaning that an increase in revenues would not have a negative impact on the level of inflation. With this in mind, the fiscal and monetary policies of Saudi Arabia are hedged to the fixed exchange rate system that has been present in the country for more than thirty years. Such a scenario happens when high incomes from the oil industry increase the level of spending by locals in the country. Increased consumption happens due to increased money supply. Whereas increased consumption is not bad for the economy, it can cause a huge imbalance in the balance of payments with huge deficits cropping up.

The policies are also supposed to ensure that there is a high rate of economic growth. These policies do so by offering incentives to local businesses and entrepreneurs who want to diversify the economy (Amar, Hachicha,& Saadallah, 2015). Such diversification has taken place through the expansion of new industries which were not present or popular in the past. Some of the industries that have developed include tourism, the real estate industry, agriculture, automotive, mining, and the healthcare industry.

SAMA has in the recent past insisted on the need to diversify the economy of the country since oil revenues are not sustainable. The world is quickly moving to renewable sources of energy and thereby oil and petroleum products could soon be a thing of the past. An industry that has been growing is the tourism industry. SAMA offers great investments for players in the industry with huge incentives being offered within the fiscal policy. Examples include reduced taxes for businesses in the tourism industry. The construction industry has also gained a great deal. Oil revenues are now being used in construction of skyscrapers which have become a major tourist attraction for hundreds of thousands of people from around the world.

Challenges when achieving the Goals

Several challenges could be observed as Saudi Arabia strives to achieve the goals that have been developed by SAMA on its monetary and fiscal policies. One of the biggest challenges is volatility in the oil industry. Any volatility in the global oil prices has negative effects on the economy. The Saudi oil policy dictates that the country should be on the forefront at controlling exports and prices of oil with the aim of creating stability which can over time bring about stability in the economy. However, the policy has not always been applied in the said manner since oil companies tend to put their interests first before those of the country. Increased or heightened regulation has not always brought the desired results and thereby other options need to be sought by the Saudi government if its fiscal and monetary policy goals are to be met in the future.

Another challenge that could be observed when striving to achieve the monetary and fiscal policy goals of the country is trying to make the policies similar to those used by Western nations. According to analysts, the framework adopted in the country does not take into consideration that the economy of the country is oil-based. It means that a large portion of the GDP is solely based on the oil industry. Any fluctuations in the global oil prices tend to have huge impacts on the country’s economic stability. The fixed exchange rate has also on certain occasions been observed to lack the ability to change as market forces change. Empowering SAMA to change the exchange rate when the oil industry is going through turmoil could be a great option to hedge against changes in the market. Regulation of foreign currency has also been difficult when huge revenues are made in the oil industry. Increased regulation on oil companies could go a long way towards achieving these goals in the long-term.

The second biggest challenge are huge challenges in policymaking. In the recent past, it has been observed that most domestic development projects are tackled using management thinking and not the principles of public policy. For a long time, Saudi Arabia government has been ruled by individuals who often ignore the principles of public policy (Rasasi,& Alqahtani, 2017). Public policy principles assert that the interest of the people should always come first when policies are being developed. This has not always been the case and this explains why some of the projects have failed. There are certain investment projects that have failed due to adoption of management thinking without considering public policy in the country. Some of the projects also tend to only attract foreign tourists without any input or attraction from the locals. Addressing the issue is critical towards ensuring that they contribute to the economic growth and sustainability of Saudi Arabia.

Instruments to overcome the Challenges

Saudi Arabia can deal with the volatility of the oil industry through controlling the oil reserves. In the recent past, oil-producing countries such as Kuwait and Iran have been affected by volatilities in the oil industry. These effects should be avoided since they would have detrimental impacts on the realization of the long-term goals of Saudi Vision 2030. The fixed exchange rate has played a critical role to try and stabilize foreign currencies such as the US dollar which is the main currency that is used when trading oil exports from the country (Fathallah, 2019). However, coming up with strategies that control the level of exports or oil reserves could prove to be critical towards maintaining a steady situation in the oil revenues. Controlling the oil reserves would also mean that the fiscal and monetary policies would no always be dependent on the oil industry which is a critical aspect for sustainability of the economy.

Another instrument that could be pursued towards achieving the set goals of the monetary and fiscal policies in the country is to ensure that public policy drives investment projects that are being made. Management thinking has been observed to be driven by interests of investors and not those of the citizens. The aim of public investment projects should be to increase the living standard of the people. Shifting the focus from making the country to be a business hub could help create value for its citizens in ways that have never been perceived before. There is also a need to consider the use of policymakers who understand the region. Most of the policies that have been adopted in the past have been developed by Westerners who are on many occasions out of touch with the needs of the people. The Saudi government needs to be on the forefront in ensuring that these changes are adopted in the monetary and fiscal policies of the country.

The volatility of the oil revenues can also be addressed through pursuing Saudi Vision 2030. The framework calls for the diversification of the economy in ways that would ensure that there is no overreliance on the oil industry. Entrepreneurs and start-ups in the country need to be supported through funding if the economy is to be diversified. Diversification should also divert attention from foreign investors to locals. Locals need to be empowered to have an influence over policies that are developed for the nation. Saudi Arabia can also deal with the challenges through employing fiscal and monetary policies that have been trialed in other regions in the world. Doing this guarantees that there are impeccable results in the economic system of the country.

Conclusion

The monetary and fiscal policy of Saudi Arabia is one of the most unique in the world. The use of a fixed exchange rate system is unique in itself and offers a wide array of benefits to the monetary system. It is also critical towards the achievement of the monetary and fiscal policies of the country. The addressed challenges and developed solutions can go a long way towards guaranteeing economic growth and sustainability in the country.

References

Al-Hamidy, A. (January 01, 2012). Aspects of Fiscal/Debt Management and Monetary Policy Interaction: The Recent Experience of Saudi Arabia. Ssrn Electronic Journal. SSRN Electronic Journal.

Amar, A. B., Hachicha, N., & Saadallah, R. (2015). The effectiveness of monetary policy transmission channels in the presence of Islamic banks: The case of SaudiArabia. International Journal of Business, 20(3), 237-260. Retrieved from https://search.proquest.com/docview/1718120865?accountid=45049

Dibooğlu, S., & Aleisa, E. (January 01, 2014). Oil Prices, Terms of Trade Shocks, and Macroeconomic Fluctuations in Saudi Arabia.

Contemporary Economic Policy, 22, 1, 50-62.

Fathallah, H. (2019, March 22). Challenges of Public Policymaking in Saudi Arabia. Retrieved from https://carnegieendowment.org/sada/79188.

Jareer, E. (2018, December 11). Saudi Arabia gears up to tackle economic challenges. Retrieved from https://thearabweekly.com/saudi-arabia-gears-tackle-economic-challenges.

Rasasi, M. A.,& Alqahtani, A. (2017). The effects of global commodity prices on domestic prices in SaudiArabia. International Journal of Economics and Financial Issues, 7(4) Retrieved from https://search.proquest.com/docview/1984688834?accountid=45049

Rashid, S., & Rousane, S. A. (2016). Gulf cooperation council stock returns and the effect of domestic monetary policy shocks. International Journal of Economics and Financial Issues, 6(2) Retrieved from https://search.proquest.com/docview/1809611932?accountid=45049