Introduction
One of the ways that a country's government can influence the economy is through monetary policies. The monetary policy goes hand in hand with fiscal policy. In such countries, the central banks have a variety of targets, which are emphasized in subsequent periods. Some of those targets include growth rates of narrow and broad money, short-term interest rates, monetary conditions, inflation, and foreign exchange rates. The central banks use complex theoretical economy models to determine the effectiveness of the policies. However, the task is often a difficult one since it is difficult to establish and substantiate the changes brought by the monetary and fiscal policies. In Saudi Arabia, the agent body responsible for that task is the Saudi Arabian Monetary Agency (SAMA). The exchange rate's role is crucial in the country's monetary policy as it is used aa an important variable for the balance of payments and price stability. Under the fixed exchange rates regime, the level of foreign exchange, and the dollar/riyal interest rates differential directly influence the Intervention Policy. The effects are noted in Saudi Arabia's foreign exchange reserves. Due to the openness of the country's economy, there are limitations to the monetary policies, as explored later in the paper.
How Fiscal and Monetary Policies Under the Fixed Exchange Help Saudi Arabia Improve Standards of Living
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According to Robert Carbaugh, all members of the IMF should not manipulate exchange rates to gain an unfair advantage over other members or hinder effective adjustments to balance-of-payments (Carbaugh, 2016). Saudi Arabia, therefore, being a member of the IMF, is bound to follow such principles. In its quest to improve standards of living, the country has come up with several exchange rate arrangements and regimes. One of the most inflexible regimes is dollarization. Under this policy, other countries' currency is used and circulated. One important point to note is that the US dollar is not necessarily used, but any foreign currency can serve the purpose (Alkhareif & Qualls, 2016). The regime is advantageous in that it reduces the country's currency crisis and facilitates disinflation. In addition to that, the transaction costs are lowered, and it leads to stable interest rates. Consequently, Saudi Arabian citizens can borrow more and pay reasonable interest amounts in their quest for investment and bettering their lives. The other policy is the currency union, where no individual nation in the union controls its monetary policy or currency (Alkhareif & Qualls, 2016). However, the individual countries making the union have a voice through the representatives they send to the currency union's central bank. There is some similarity in the advantages of dollarization and the currency union. However, the benefits benefit the country's economy as a whole. For instance, through representation in the union's central bank board, some autonomy is gained. For this reason, Saudi Arabia can self-govern without the control of monetary policies. Considering the policies are regulated by the union, Saudi Arabia's citizens will enjoy better fiscal policies, which will enable them to improve their lives.
Anchoring to a single currency is often done by developing countries that partner with a single-industrial nation in its financial and trade relations (Carbaugh, 2016). Such nations like Saudi Arabia anchor to Special Drawings Right (SDR), which is in line with its other regime, the fixed or conventional peg. The regime gives power to the country's central bank in several ways. To begin with, the central bank is not statutorily mandated to maintain the peg at the start rate. The central bank can adjust the peg either upward or downward, particularly when the problem of misalignment arises (Alkhareif & Qualls, 2016). Additionally, the central bank can also actively defend the peg directly by interventions in the forward and step markets, or indirectly through domestic interest rates (Alkhareif & Qualls, 2016). Although limited, most of the functions of the central bank are possible, and this results in free capital movements. When a country's central bank is fully functional, the effects trickle down to the other local banks and eventually to the citizens. Once the capital movements are frequent, it means that local citizens can easily access such capital. Consequently, they can expand their economic capabilities by diversifying their businesses and making investments. The results of this are improved lifestyles and standards of living. Some of the advantages of a fixed peg regime in Saudi Arabia include the stability of the economy, lower interest rates, moderation of inflation, and an easily understandable nominal anchor (Alkhareif & Qualls, 2016).
Goals of the Monetary Policies and How They Can Be Achieved
Apart from being one of the most water-stressed countries in the world, Saudi Arabia is also characterized by low income and heavy dependence on oil. Subsequently, the country's alliances and relations with neighboring countries play a significant role in its social welfare and economic growth. In Saudi Arabia, most of the country's wealth is held by the elite few, mostly comprising of the ruling class. The majority of the citizens, therefore, fall under the low-income earners' category. The two principal characteristics of such people are low saving ratios, which equates to low investments and limited taxable capacity, which leads to deficits in the government's budgets. Consequently, Saudi Arabia's economy is heavily dependent on the foreign capital influx. After the outbreak of the global financial crisis affected nations across the world, central banks were mandated to manage their monetary policies. Although the financial crisis mostly affected the developed nations, it provoked significant challenges in developing nations as they lagged further behind in economic growth rates. One of the countries that developed and updated its monetary policy is Saudi Arabia. The monetary policy's main objective is maintaining monetary stability as well as keeping an inclusive and sustained economic growth. To achieve the goal, the Saudi Arabian government seeks to maintain the general price of commodities. Moreover, it aims at establishing an interest structure that is not only fair for its citizens but also in line with the rule and regulations of local and global economies. For instance, the economic objectives of nations include overall balance, long-term economic growth, as well as reasonably equitable distribution of the countries' national income (Carbaugh, 2016). Therefore, Saudi Arabia's monitory policy should be directed toward economic stability and zero inflation.
The second monetary goal for Saudi Arabia is the maintenance of a stable and convertible currency. At the moment, 1 US dollar equals 3.75 Saudi Riyal, which means that the country has a stable currency. Its reserves management policy banks the stability of Saudi Arabia's currency. For instance, that any given time, the policy mandates that the market's foreign reserves should not go below 70% of the country's monetary base value. In other words, the implementation of SAMA's monetary policy aims at ensuring short-term exchange rates align with US rates. SAMA does so by maintaining an adequate liquidity level. Saudi Arabia is one of the leading exporters of oil, and it thus maintains a consistent current account. For this reason, the Saudi government has little need to maintain its funding through debt insurance. In the banking sector, liquidity is maintained through issuing of Certificates of Deposit (CDs) and required reserves. With this approach, the short-term bank loan rates will reduce, which is in tandem with the intended monetary policy goal. This is because a persistent current account surplus, in line with monetary policy implementation, allows a constant and persistent excess structural liquidity.
Challenges Faced in the Journey to Achieve the Goals
Ample liquidity levels have characterized the Saudi Arabian financial system for the last decade due to low levels of domestic interest rates as well as high oil prices. However, in the second half of 2014, oil prices significantly dropped, which led to challenges (Almalki & Batayneh, 2015). The issues particularly affected the country's monetary policies. The first challenge that the drop presented was liquidity issues. The government's budget also experienced major deficits. The local banks could feel the effects because the government initiated a local debt issuance program that the banks were to follow. For these reasons, Saudi Arabian banks directed parts of their liquidity to the government bonds that were newly implemented. The result of this was crowding in the private sector. Moreover, the subscription of Autonomous Government Institutions, another disaster management strategy to the bonds, was financed through deposits withdrawals from the banks. The move further tightened liquidity. The other effects of the problem included a drop in the money supply indicators, an increase in regulations, and unfavorable market conditions.
The second major challenge that Saudi Arabia experiences in its quest to achieve monetary policy goals is inflation. According to SAMA's inflation report, international factors like global economic activities and international financial market developments caused inflation (Almalki & Batayneh, 2015). What is more, domestic factors such as a decrease in the aggregate supply of goods, monetary factors, as well as change in the prices of imported goods impacted on inflation. Considering that Saudi Arabia is an open economy, and most of the locally used products are imported, external factors significantly contribute to inflation. The fluctuations in oil prices do not help either as they lead to a shift in the value of the US dollar against other currencies, the Saudi Riyal being one of them. Inflation poses a substantial threat to achieving the country's monetary goals and objectives. For example, one of the goals is strengthening of the currency. Inflation leads to an increase in the price of commodities, which means that local consumers spend more on necessary items. Coupled with the already weakened US dollar, this eventually weakens the Riyal. Inflation also strains the government's implemented policies. For instance, the Saudi government set up various reforms, including the Fiscal Balance Program, but they ended up increasing inflation. The 2014 drop in oil prices had some effects, such as substantial budget cuts in 2015 (Almalki & Batayneh, 2015). Considering the situation did not improve, the budget was further tightened by cutting out unnecessary costs. Consequently, achieving monetary goals proves strenuous as the government is stuck between fulfilling the most important country's needs and fulfilling monetary objectives, with an already limited budget.
Instruments Saudi Arabia Can Use to Overcome These Challenges
To avert liquidity challenges, there are some mechanisms that Saudi Arabia can use. The first one is restructuring the governance framework to ensure that it is reflective of the market conditions. The mechanism is in line with the International Organization of Securities Commission's principles for a financial benchmark. Principle seven recognizes the various indices that may be used to reflect the performance of an active market (Chiu, 2016). The second strategy is reducing the aggregate ceiling of SAMA bills subscription. The aim of such a strategy would be redirecting the liquidity that was invested in SAMA bills towards the financial system. The expected result of such a move is increased liquidity levels. In the same way, another strategy would be introducing new tenors for the Repo Facility with the intent of strengthening the existent overnight Repo Facility. The current Repo facility only provides solutions for an extremely short time. Consequently, the strategy would provide an additional source of funding as well as a tool for local Saudi banks to manage liquidity for periods longer than overnight basis. The overall issue is the complementarity of fiscal and monetary policies. While the set monetary goals for Saudi Arabia are of paramount importance, it is crucial to align them with fiscal measures. The reason behind that is to enhance the capability of Saudi's financial system to enable it to perform its role of financing large amounts of the financial debt while keeping track of liquidity levels.
When it comes to averting the inflation crisis, several fiscal measures can be implemented. The first one is the strengthening of non-oil revenue sources. Saudi Arabia made a landmark achievement with revenue collection by introducing the VAR, whose registration began in early 2019 (Almalki & Batayneh, 2015). The registration has been smooth, but the process can be broadened to accommodate other items. For instance, excise duty should include cigarettes and sugar-sweetened beverages, which have high demand in the country. In the same way, tighter fiscal policy is necessary. Most of the inflation challenges come from the country's open economy. For this reason, the Non-Exported Oil Primary Deficit should be largely reduced to lessen fiscal vulnerabilities. Once the vulnerabilities are reduced, it creates additional fiscal space, which leads to an increase in the capital spending that supports growth and diversification of non-oil revenues. In doing so, the dependence on oil income is reduced. Consequently, should there be a crisis that results in a drop in oil prices, such accumulated non-oil incomes will come in handy in financing the government's budget. The Saudi Arabian government, therefore, will not result in drastic measures such as unexplained budget costs that strain development. Instead, the government will function as usual and still preserve a portion of the budget towards achieving monetary policies' goals and objectives. The final recommendation is prioritizing the implementation of the recommended fiscal measures. At the moment, the Saudi economic environment is filled with loopholes. The first one is an open economy dependent on external factors, and the second is a dependency on one major income generator, which is oil. Therefore, the recommended fiscal policies should be implemented in a matter of haste. In as much as the global prices of oil have stabilized, one little problem could trigger the prices, and Saudi Arabia could begin the crisis management cycle all over again.
Conclusion
Conclusively, there are several fiscal and monetary policies under the exchange rate in Saudi Arabia. Such policies include dollarization, where another country's currency is used and anchoring to a single currency through the Special Drawing Rights, which strengthens the central bank. Saudi Arabia has several monetary policy goals that work towards improving the living standards of the citizens. Such goals include maintaining monetary stability, maintaining a stable and convertible currency, and establishing a fair interest structure. However, there are some challenges in the journey. Some of them are liquidity issues and inflation. When it comes to inflation, the instruments that can solve the problem include tighter fiscal policies, strengthening non-oil income generating avenues, and prioritizing implementation of policies. In the case of liquidity challenges, some of the recommended solutions include restructuring of government frameworks, reducing aggregate ceiling of SAMA bills, and introducing new tenors for the Repo Facility to strengthen it. Once such recommendations have been put in place, the Saudi Arabian government will be right on track with the fiscal and monetary policy goals and objectives.
References
Alkhareif, R. M., & Qualls, J. H. (2016). Saudi Arabia's Exchange Rate Policy: Its Impact on Historical Economic Performance (Vol. 16, No. 4). SAMA Working Paper.
Almalki, A. M., & Batayneh, K. I. (2015). The Relationship Between Inflation and Financial Development in Saudi Arabia. The Journal of Developing Areas , 49 (6), 321-332.
Carbaugh, R. (2016). International Economics . Boston, MA: Cengage Learning.
Chiu, I. H. Y. (2016). Regulating Financial Benchmarks By ‘Proprietization’: A Critical Discussion. Capital Markets Law Journal , 11 (2), 191-227.
