The moderation of the Kingdom’s business cycle since the end of 2014, with oil prices plunging from above USD 100 per barrel to multi-year lows, have intensified the debate about the country’s counter-cyclical buffers with a multitude of questions centred around how large, and in what form. For how long can these reserves last? And even though the National Transformation Program 2020 and Saudi Vision 2030 had mitigated concerns about the country’s finances with the government adopting fiscal consolidation and adjustment in order to ensure economic sustainability, the issue of assessing the adequacy of Saudi reserves and foreign assets in the face of myriad shocks remains as relevant as ever.
Let me start by underscoring the importance of reserves, in the form of net foreign assets, as a critical source of liquidity support to an economy during unfavorable business cycles. The optimal level of reserves depends on economic maturity, cross-border financial transactions, size of banking system and the degree of openness of the capital account. As such, there are three individual metrics to assess reserve adequacy in the event of a shock, the first of these being import coverage that is used to measure the ability to sustain imports of goods and services, with the widely used benchmark set at three months’ coverage. Second, reserves to short-term external debt, which measures a country’s rollover/refinancing risk, with 100 percent coverage as the standard for emerging economies.
This had been a critical metric since the 1997 East Asian financial crisis that was triggered by these countries’ plunging currencies, which inflated their debt burdens given the high dependence on short-term foreign lending. And the final metric is the ratio of reserves to money supply that is concerned with the impact on capital accounts from the risks of capital flight during a crisis. The standard of adequacy for this measure is usually cited at 20 percent.
Assessing the sufficiency of the Kingdom’s net foreign assets given the aforementioned metrics underscores the lack of immediate stress, with all the measurements above the agreed upon adequacy standards.
By the end of last year, net foreign assets covered around 30 months of imports and were also 12 times the short-term external debt whether private or public. As for the adequacy compared to the broadest measure of money supply, which in the case of Saudi can be M2 that includes demand and time & savings’ deposits, the ratio was at 130 percent, above the 20 percent threshold.
However, given the fact that global and regional economic crises did exhibit stress via multiple channels, the use of a metric that combines most of these variables is more realistic in capturing a range of risks than individual measures. Accordingly, the IMF metric for emerging markets with fixed currency regime have been used since it assesses the adequacy of reserves relative to short-term debt, other liabilities, money supply as well as accounting for exports that will be negatively impacted during shocks. Even after applying this all encompassing metric, Saudi reserves remained adequate at 7 times coverage, despite declining since 2013, which implies that the economy can cover its financing needs, withstand capital outflows, and sustain its imports.
From a dynamic perspective rather than the above static analysis, I believe that the recent bout of fiscal reforms will underpin the adequacy and sustainability of reserves.
Tamer El Zayat is the Vice President and Head of Macroeconomics at Jeddah-based NCB Capital
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