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DUBAI, Jan 20, 2016:

The Saudi Arabian central bank has warned commercial banks against betting on depreciation of the riyal as tumbling oil prices put pressure on the Saudi currency, several bankers operating in the market said.

The action by the Saudi Arabian Monetary Agency (SAMA) suggests authorities want to prevent investors’ unease over the impact of cheap oil on the Saudi economy from triggering capital flight or destabilising local markets.

The riyal, pegged in the spot market at 3.75 to the US dollar since 1986, hit a record low against the dollar in the one-year forwards market last week as some banks and funds hedged against the risk that low oil prices might eventually prompt Riyadh to scrap the peg.

In order to pay the government’s bills as its oil revenues shrink, SAMA has been drawing down its overseas assets at an annual rate of more than US$100 billion, although it still has enough to support the riyal for several years.

The bankers, declining to be named because of commercial sensitivities, said SAMA had contacted them privately and urged them not to conduct derivatives trades that would pressure the riyal.

“SAMA has ordered banks to stop giving structures for FX swaps. I mean banks can quote for straight forwards and FX swaps, but can’t price for swap options,” said one banker.

The bankers said SAMA’s action was so far succeeding in supporting the riyal.

One-year dollar/riyal forwards had dropped back to 690 points today from a record 1,020 points last week, even though Brent crude has hit fresh 12-year lows below US$30 a barrel.

Saudi Arabia faced two previous bouts of speculation against its currency after 1986, according to a 2013 paper by former SAMA vice-governor Abdulrahman al-Hamidy and Ahmed Banafe, published on the Bank for International Settlements website.

In both cases, cheap oil fuelled concern about budget and external deficits.

Both times, SAMA quashed speculation fairly easily by gathering information about speculative positions through its contacts with local banks, then pushing the riyal back up in the forwards market with steps such as placing deposits with domestic banks, the paper found.

“In episodes of speculation against the riyal…SAMA’s tactics were effective, and they are still available for use,” Hamidy and Banafe wrote in their paper.

Bankers noted that after falling slightly below 3.7500 to the US dollar in the spot market earlier this month, the riyal had in recent days rebounded very close to that level, suggesting SAMA was providing an ample supply of dollars to the market.

Current forward market prices only imply riyal depreciation of about 1.8% in the next 12 months, and many Gulf bankers think Riyadh remains very unlikely to depreciate its currency.

That is because any benefit to state finances from higher oil revenue, after converting dollars to riyals, would be more than outweighed by a surge in import costs – politically uncomfortable for the government – and a market panic.

But even as pressure on the riyal in the forwards market has eased in the last few days, the interest rate swaps market, also used to bet on depreciation, shows traders remain nervous.

Two-year Saudi IRS climbed to 2.62% yesterday, their highest since 2008. They have jumped 1.26 percentage point since September, a massive rise considering the Saudi central bank has raised official interest rates by only 0.25 percentage point in the period.

With IRS, an investor can choose to receive a floating interest rate while paying fixed. So IRS are a bet that Riyadh will hike rates sharply in coming years to defend its currency or to stabilise it once the peg has been removed.

The currencies of Saudi Arabia’s wealthy oil exporting neighbours have also come under pressure in the last few months, though in most cases to a lesser extent. Kuwait’s dinar dropped in the one-year forwards market on Tuesday to its lowest level since 2009.

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