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Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Currency Wars and its impact on Saudi Arabia 1 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Contents 2 Executive Summary 4 Evolution of emerging market currencies since 1970 5 Low exchange rates to boost economy 9 Currency war intensifies after 2014 20 Chinese Yuan devaluation 22 GCC economies stable enough to weather devaluation of yuan 27 APPENDIX 32 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back List of Figures 3 Figure 1 Exchange Rate Regime Timeline 5 Figure 2 Declining proportion of countries with their currencies pegged (as a % of total) 6 Figure 3 Developing markets exchange rate regime 6 Figure 4 GDP (USD bn) v/s exchange rates chart 9 Figure 5 Current Account Balance (USD bn) v/s exchange rates chart 12 Figure 6 Exports (USD bn) v/s exchange rates chart 14 Figure 7 Unemployment rate v/s exchange rates chart 18 Figure 8 Kazakhstan Exports by Country 21 Figure 9 Kazakhstan Exports by Product 21 Figure 10 Currency war after 2014 22 Figure 11 Evolution of Yuan from fixed peg to floating 23 Figure 12 Total Exports (USD bn) 24 Figure 13 Total Reserves (USD tn) 24 Figure 14 Net FDI inflow (USD bn) 24 Figure 15 Total Exports (%) 26 Figure 16 China GDP growth (%) 26 Figure 17 China trade statistics 27 Figure 18 China crude oil imports (mn bpd) 27 Figure 19 GCC countries net foreign assets (USD bn) and as a percentage of gross debt 28 Figure 20 Country-wise UAE’s import share 29 Figure 21 Country-wise UAE’s export share 29 Figure 22 SAR forward point vs Yuan 30 Figure 23 TASI vs Yuan 30 Figure 24 Saudi Arabia net foreign assets (SAR bn) 30 Figure 25 Saudi trade statistics (2014) 31 Figure 26 Saudi Current Account Balance 31 Figure 27 USD/ Euro 32 Figure 28 USD/ Yen 32 Figure 29 USD/ Yuan 32 Figure 30 USD/ Russian Ruble 32 Figure 31 USD/ Kazakhstan Tenge (KZT) 32 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Executive Summary 4 • The currency as a concept has witnessed huge transformation during the last century. During this period, the world has faced many currency crises and currencies have evolved at every such incident. • Over the years, exchange rates have played a vital role in determining a country’s economic health. The emerging markets have historically witnessed a push in their economic output after the devaluation of their currencies. Countries, such as China, have managed their exchange rates to boost their exports. Furthermore, exchange rates have a strong correlation with factors, such as interest rate, unemployment, and inflation. • Since 1970, many countries have resorted to currency devaluation for improving their economic condition. Indonesia devalued its currency during the financial crisis of 1997 to protect itself. Similarly, Argentina devalued Peso in 2002 so that its exports remain competitive in comparison to other emerging economies, such as Brazil, which had transformed its regime to floating rate during the same period. • Currency wars have emerged significantly after 2014 and the magnitude of the war can be gauged from the turn of events, ranging from the crash of the Russian ruble to devaluation of yen in October 2014 and depreciation of yuan in August 2015, followed by depreciation of Kazakhstani tenge. European Central Bank President Mario Draghi recently announced that if required, the Eurozone could undertake another round of quantitative easing, which would further increase volatility in the currency market. • For long, China had pegged yuan to the US dollar, which led the exports and foreign exchange reserves to increase during periods of high growth. During the period of fixed peg, exports increased exponentially to about USD 2.4tn in 2013 from USD 9.8bn in 1978. However, currently, as China is experiencing slow growth, the government has allowed Yuan to devalue and shifted toward managed floating rate regime. This would aid in China’s vision of making yuan a global currency by adding it to the SDR basket. • As China contributes around 12% to the total world trade, the depreciation of yuan would lead to a rise in exports from China. Conversely, exporters to China would witness a decrease in demand. China imports more than 14% of steel globally and is the largest importer of crude oil in the world. • The Chinese yuan policy is expected to have a limited impact on trade between GCC and China. The recent devaluation is too negligible to impact the oil demand, as oil prices have dropped over 50% compared with the 4% decline in yuan in 2015. As GCC countries have sufficient assets, they can cope with deficits without abandoning their currency pegs. Saudi Arabia and the UAE have enough foreign assets to serve their debts. Saudi Arabia’s net foreign assets can cover its debt by over 60 times. • China is Saudi Arabia’s largest trade partner, accounting for 12.5% of total exports and 13.4% of total imports. Hence, the devaluation of yuan would make imports to KSA from China cheaper, but would impact the exports. Moreover, if the measures undertaken by the People’s Bank of China do not spur growth in China, the impact could be severe. We expect the trade balance to be marginally affected and current account balance as a percentage of GDP to decline, but within a sustainable level. © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Evolution of emerging market currencies since 1970 The recent move by China to devalue yuan has shifted the focus back on currency wars. The currency as a concept has witnessed significant transformation in the last century. During this period, the world has faced many currency crises and the currencies have evolved at every such incident. The pre-World War II era was characterized by currency crisis, primarily due to wars. The post-World War era can be further classified into pre-Bretton Woods phase (before 1973) and post-Bretton Woods phase (after 1973). In the Bretton Woods phase, the member countries declared the par value for their currency, either in terms of gold or USD. The countries had to intervene to maintain the exchange rates within the range. However, the Bretton Woods system collapsed in 1970s, and thereafter the world suffered from various currency crises, such as the Mexican currency crisis in 1980s and 1994 and the Asian currency crisis in 1997. Figure 1 Evaluation of exchange rate regime 1944 Bretton Woods system established a dollar standard; the dollar was fixed at USD 35/ounce of gold 2000s More emerging markets shifted toward floating rate system 1990s Emerging markets started converting their currencies from pegged to floating Pre -world war Gold standard currency. Currencies were fixed/pegged to gold and the value of gold held fixes currencies 1973 Failure of Bretton Woods system and entry of flexible exchange rates 2015 China devalued yuan, bringing back currency wars to the fore 2014 -15 Price wars started again; China aims to make Yuan an international currency 1997 Asian currency crisis brought to fore the significant currency issues in emerging economies Source: IMF, AlJazira Capital Research 5 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Rapid shift in exchange rate regime in developing markets after Bretton Woods After Bretton Woods agreement, most developing countries initially continued to peg their currencies. However, from late 1970s, they began shifting toward basket pegs. Since 1980s and 1990s, more developing economies moved toward flexible exchange rate regime. About 87% of developing economies had their currencies pegged to some exchange rate in 1975. This number dropped significantly to below 50% by 1996. Figure 2 Declining proportion of countries with their currencies pegged (as a % of total) 1975 87% 1996 50% 2015 22% Source: IMF, AlJazira Capital Research With time, the proportion of currencies pegged has dropped and economies globally are moving toward freely moving exchange rate regime. Figure 3 Developing markets exchange rate regime Late 1970s Countries started shifting toward free exchange rate regime 1970 Most currencies were pegged (~87% of developing markets) 1973 Fall of Bretton Woods System 2005 China, the largest developing market, abandoned its peg and moved toward managed floating rate 1997 Asian currency crisis brought currency concerns to the fore 1980s - 1990s More developing markets shifted from pegged to free regime (1996 share: lower than 50%) 2015 Proportion of emerging markets with currencies pegged has dropped to ~22% Post - currency crisis Exited from pegged regime due to the crisis Source: IMF, AlJazira Capital Research 6 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back However, some countries, particularly GCC, buck this trend The trend of transforming into flexible exchange rate regime has picked up pace. However, there were several exceptions as well to this. Around 14 countries, the CFA franc zone in sub-Saharan Africa, have pegged their exchange rate to the French franc since 1948, with only one significant devaluation in 1994. Some countries, such as Argentina in 1991 and Hong Kong SAR in 1983, even reverted back to fixed rate system. However, by late 1990s, the flexible rate regimes dominated most regions globally. Argentina abandoned its fixed rate regime after the 2001 crisis. GCC countries, except Kuwait, have not followed this trend and their currencies are pegged to date. Table 1: List of countries with pegged currencies Country Region Bahrain Currency (ccy) name Peg rate Peg ccy Rate since Middle East Dollar 0.3760 USD 2001 Benin Africa West African CFA Franc 655.9570 EUR 1999 Bosnia and Herzegovina Europe Convertible Mark 1.9558 EUR 2002 Bulgaria Europe Lev 1.9558 EUR 2002 Burkina Faso Africa 655.9570 EUR 1999 655.9570 EUR 1999 655.9570 EUR 1999 Chad Africa Cuba Central America West African CFA Franc Central African CFA Franc Central African CFA Franc Central African CFA Franc Convertible Peso Denmark Europe Krone Djibouti Africa Cameroon Africa Central African Republic Africa 655.9570 EUR 1999 1.0000 USD 2011 7.4604 EUR 1999 177.7210 USD 1973 655.9570 EUR 1999 15.0000 USD 2005 655.9570 EUR 1999 655.9570 EUR 1999 USD 1998 Gabon Africa Guinea-Bissau Africa Franc Central African CFA Franc Nakfa Central African CFA Franc West African CFA Franc Asia Dollar 7.75-7.85 Equatorial Guinea Africa Eritrea Africa Hong Kong Ivory Coast Africa West African CFA Franc 655.9570 EUR 1999 Jordan Middle East Dinar 0.7090 USD 1995 Lebanon Middle East Pound 1507.5000 USD 1997 Lesotho Africa Loti 1.0000 ZAR 1980 Mali Africa West African CFA Franc 655.9570 EUR 1999 Namibia Africa Dollar 1.0000 ZAR 1993 Nepal Asia Rupee 1.6000 INR 1993 Niger Africa West African CFA Franc 655.9570 EUR 1999 Oman Middle East Rial 0.3845 USD 1986 Central America Balboa 1.0000 USD 1904 Middle East 3.6400 USD 2001 655.9570 EUR 1999 Middle East Riyal Central African CFA Franc Riyal 3.7500 USD 1986 Senegal Africa West African CFA Franc 655.9570 EUR 1999 Swaziland Africa Lilangeni 1.0000 ZAR 1974 Togo Africa West African CFA Franc 655.9570 EUR 1999 UAE Middle East Dirham 3.6725 USD 1997 South America Bolivar 6.3000 USD Panama Qatar Congo Saudi Arabia Venezuela Africa 2013 Source: Investment Frontier 7 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Shift toward floating rate regime by emerging economies Most economies had their currencies pegged for the majority of the part post-World War II era. However, emerging market currencies have been progressively transforming from fixed to freely traded currencies since the late 1990s. There are still few countries that manage currency movements and few, such as GCC countries, have their currencies pegged to USD. The loosening of currency control and credible monetary policy has resulted in many emerging countries resisting global shocks and avoiding crisis. Instances of changing currency systems of emerging economies Brazil Brazil was able to keep its currency pegged and inflation under control during the early 1990s due to huge liquidity in the global market. However, overvalued currency, coupled with external shocks and recession, during 1998–2002 led to the collapse of Brazil’s exchange rate regime in 1999. The Brazilian central bank, which kept its currency under tight control until then was forced to abandon the control and move toward floating exchange rate system. Russia Russian ruble has also shown gradual movement toward flexible exchange rate system. The Russian default in 1998 crumbled the domestic as well as international markets. The fixed exchange rate regime and fragile fiscal position of Russia became unsustainable due to spillover effects of global financial distress. Russian government then announced significant devaluation of ruble in August 1998. Eventually, Russia abandoned the currency corridor and adopted freely floating exchange regime in September 1998. The government revamped the restrictive capital regulations in 2004 and 2009 onward the Bank of Russia has largely reduced its intervention in the market. The Bank intends to transition ruble into a completely floating rate regime. In 2014, Bank of Russia moved ahead with fully floating the Ruble. The central bank removed the dual-currency trading band methodology to calculate the nominal exchange rate and abandoned the policy of daily foreign exchange interventions by the Central Bank to stabilize its currency. The move was prompted by the largest weekly drop in ruble in 11 years during November 2014. China Chinese exchange rate policy has witnessed significant changes since the crash of Bretton Woods system in 1973. Chinese renminbi was pegged to USD for majority of the time. However, to boost exports, China allowed its currency to devalue in 1980s and 1990s and finally lifted the peg in 2005. The currency is now under tightly managed floating regime. The exchange rate is maintained within tight, but relaxing bands against USD. The bands increased from initial ±0.3% to ±2% in 2014 and to ±3% as recently as July 2015. Dwindling exports has led the country to loosen its strings and allow the currency to depreciate. China has always been blamed by global economies for manipulating its currency. The People’s Bank of China (PBoC) pledged to allow the market a greater role in determining the exchange rate, but this will be a long process. India India’s exchange rate regime has evolved significantly during the reform period after 1990. From a nominal fix rate regime to one-way movement in 1990s to two-way with low volatility (a tightly managed exchange rate) to nominal movement and greater volatility after the global crisis in 2007–08. Saudi Arabia The Saudi riyal has been pegged to USD at SAR 3.745 per USD since 1986. The exchange rate was determined by the Saudi Arabian Monetary Agency (SAMA). SAMA and Ministry of Finance administer the foreign exchange rates. SAMA has maintained its stance of limited intervention in the market to control the exchange rate. The SAMA intervened in the foreign exchange market last in 1998. Poland Similar to many economies that transitioned from centralized administrative model to market economy during the 1990s, Poland also witnessed a significant inflation during the phase. The inflation in Poland peaked to over 500% in 1990. To control the inflation, Poland shifted to a fixed exchange rate regime, with the currency pegged to USD. However, the fixed rate system was not able to solve the issue. Hence, in 1991, the government devalued the zloty (Poland currency) and switched to crawling peg. However, the new regime was still not flexible and led to devaluation of the currency. Hence, in 1995, the country moved into a crawling band regime. Thereafter, Poland kept increasing the band and eventually shifted to floating rate system in 2001. Kuwait Kuwait is the only country in GCC that has not pegged its currency (KWD) to USD. In 2007, Kuwait abandoned the dollar peg it had adopted in 2003 to switch to the previous basket peg system. During 1975–2003, KWD was pegged to a weighted currency basket. The rising inflation levels due to depreciation of USD against other currencies prompted the government to shift its stance. Currently, KWD is the world’s most valuable currency. 8 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Low exchange rates to boost economy Over the years, exchange rates have played a vital role in determining a country’s economic health. Beneficial exchange rates help to boost the level of trade of the country along with other economic factors. The exchange rate regime and the rate of exchange impact various economical and financial factors of a country, such as exports, trade balance, and current account balance. We analyzed the trends of historical exchange rate regimes of 1 emerging market economies with the following parameters: • GDP • Inflation • Current Account Balance • Exports • Unemployment Rate GDP recovery following low exchange rate period The emerging markets have historically witnessed a push in their economic output after the devaluation in their currencies. The push was primarily driven by rising exports due to lower exchange rates. Figure 4 GDP (USD bn) v/s exchange rates South Africa GDP cycle of rise and fall corresponding to exchange rate during 2000-04 14 11.2 9 360 270 5.6 180 2.8 90 0 0 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 8.4 South African Rand (USD) 1 450 Argentina, Brazil, China, Mexico, Russia, Saudi Arabia and South Africa © All rights reserved GDP (USD bn) (RHS) Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Saudi Arabia 800 4.0 3.9 600 3.8 3.6 Devaluation of Riyal from 1983-1986 leading to lower GDP. Later, pegging Riyal exchange rate lead to GDP growth. 3.5 3.4 3.3 400 200 3.1 0 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 3.0 Saudi Riyal(USD) GDP (USD bn) (RHS) Falling GDP due to sanctions prompting devaluation of currency Russia Currency devaluation in 1999-00 followed by recovery in GDP in 2001 80 64 48 2,500 2,000 1,500 32 1,000 16 500 Russian Ruble(USD) Jan-15 Jan-14 Jan-13 Jan-12 Jan-11 Jan-10 Jan-09 Jan-08 Jan-07 Jan-06 Jan-05 Jan-04 Jan-03 Jan-02 Jan-01 Jan-00 Jan-99 Jan-98 Jan-97 Jan-96 Jan-95 Jan-94 0 0 GDP (USD bn) (RHS) Mexico Growing GDP during 18 14 11 7 2007-09; falling rates 1,120 Period of rising GDP and falling exchange 840 rates 560 280 0 0 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 4 Mexican Peso(USD) 10 1,400 © All rights reserved GDP (USD bn) (RHS) Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back China Currency devaluation by 10.0 12,000 China after 1990 to fuel growth 7.5 9,000 Increasing GDP from 2006 to 5.0 6,000 2015 due to low exchange rates 2.5 3,000 0.0 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 0 Chinese Yuan(USD) 8 GDP growth corresponding to falling rates Argentina Rising GDP from 2004-09 after currency devaluation in 2002 (Crisis) 10 GDP (USD bn) (RHS) 720 600 480 6 360 4 240 -15 -14 Jan -13 Jan -12 Jan -11 Jan -10 Jan -09 Jan -08 Jan -07 Jan -06 Jan -05 Jan -04 Jan -03 Argentine Peso(USD) Jan -02 Jan -01 Jan -00 Jan -99 Jan -98 Jan -97 Jan -96 Jan -95 Jan Jan Jan Jan Jan Jan -94 0 -93 0 -92 120 -91 2 GDP (USD bn) (RHS) Source: IMF, Oanda, World Bank, AlJazira Capital Research 11 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Low exchange rate boosts current account balances Currency devaluation renders the goods of a country cheaper for the importing countries. Hence, the country’s competitiveness in exports increases, leading to higher exports. On the other hand, imported goods become costly for the country and the value of goods imported reduces. Hence, depreciation in the exchange rate generally improves the current account of an economy and appreciation worsens the balance. Figure 5 Current account balance (USD bn) v/s exchange rates South Africa 14 0 11 -5 8 -10 6 -15 Huge Current Account Deficit during 2012-14 leading to currency devaluation 3 0 Jan-05 -20 -25 Jan-06 Jan-07 Jan-08 Jan-09 South African Rand(USD) Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Current Account Balance (USD bn) (RHS) Saudi Arabia 3.78 180 Saudi Arabia has maintained its peg within limits without any impact on Current Account 3.76 144 3.74 108 3.72 72 3.7 36 3.68 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Saudi Riyal(USD) Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 0 Current Account Balance (USD bn) (RHS) Russia 90 75 100 60 80 45 60 30 40 15 20 0 12 120 Russia saw inverse relation in 2014 due to rise in exports Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Russian Ruble(USD) © All rights reserved Jan-10 Jan-11 Jan-12 Jan-13 Current Account Balance (USD bn) (RHS) Jan-14 Jan-15 0 Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Mexico 21 0 18 -5 15 -10 12 -15 Rising deficit in 2009 leading to currency devaluation 9 6 -20 -25 -30 3 -35 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Mexican Peso(USD) Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Current Account Balance (USD bn) (RHS) India 70 0 56 -20 42 -40 28 14 0 -60 Currency devaluation during 2010-13 due to rising deficits Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Indian Rupee(USD) -80 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 -100 Current Account Balance (USD bn) (RHS) China 450 8.4 Rising surpluses corresponding to currency appreciation during 2006-09 7.8 360 270 7.2 180 6.6 90 0 6.0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Chinese Yuan(USD) 13 © All rights reserved Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Current Account Balance (USD bn) (RHS) Jan-15 Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Brazil 4.2 20 3.6 0 3 -20 2.4 -40 1.8 -60 Rising deficits corresponding to currency appreciation during 2012-14 1.2 0.6 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Brazilian Real(USD) Jan-10 -80 -100 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 -120 Current Account Balance (USD bn) (RHS) Source: IMF, Oanda, World Bank, AlJazira Capital Research Countries using exchange rates to boost exports Historically, countries, such as China, have managed their exchange rates to boost exports. The low exchange rate maintained by China significantly boosted its exports over the years and made it the largest exporter globally. Various other emerging markets have benefited from low exchange rates and suffered during periods of high exchange rates. Figure 6 Exports (USD bn) v/s exchange rates South Africa 140 14 12 Currency devaluation in 2005-09 leading to higher exports 10 8 100 80 60 4 40 2 20 0 0 Jan-71 Jan-72 Jan-73 Jan-74 Jan-75 Jan-76 Jan-77 Jan-78 Jan-79 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 6 South African Rand (USD) 14 120 © All rights reserved Exports of Goods and Services (USD bn) (RHS) 20 15 0 15 © All rights reserved Russian Ruble(USD) Mexican Peso(USD) Exports of Goods and Services (USD bn) (RHS) Jan-15 Jan-14 Jan-13 Jan-12 Jan-11 Jan-10 Jan-09 Jan-08 Jan-07 Jan-06 Jan-05 Jan-04 Saudi Riyal(USD) Jan-03 Jan-02 80 Jan-01 Jan-71 Jan-72 Jan-73 Jan-74 Jan-75 Jan-76 Jan-77 Jan-78 Jan-79 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 5 Jan-00 Jan-99 Jan-98 Jan-97 Jan-96 Jan-95 Jan-94 0 Jan-71 Jan-72 Jan-73 Jan-74 Jan-75 Jan-76 Jan-77 Jan-78 Jan-79 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Saudi Arabia Saudi Arabia has maintained its peg within limits with exports primarily driven by oil 450 4 360 3 270 2 180 1 90 0 0 Exports of Goods and Services (USD bn) (RHS) Russia Maintained low exchange rates to drive exports 800 60 600 40 400 20 200 Currency devaluation in 1988-2001 leading to higher exports 5 0 Exports of Goods and Services (USD bn) (RHS) Mexico 500 400 10 300 200 100 0 Jan-71 Jan-72 Jan-73 Jan-74 Jan-75 Jan-76 Jan-77 Jan-78 Jan-79 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 0 16 Jan-71 Jan-72 Jan-73 Jan-74 Jan-75 Jan-76 Jan-77 Jan-78 Jan-79 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-71 Jan-72 Jan-73 Jan-74 Jan-75 Jan-76 Jan-77 Jan-78 Jan-79 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Kuwait 0.40 The exports are primarily driven by oil prices Kuwaiti Dinar(USD) 56 42 Indian Rupee(USD) 10 8 © All rights reserved China has maintained low exchange rates to drive exports Chinese Yuan(USD) Exports of Goods and Services (USD bn) (RHS) 140 0.35 112 0.30 84 0.25 56 0.20 28 0.15 0 Exports of Goods and Services (USD bn) (RHS) India 70 500 Low exchange rates driving exports 400 300 28 200 14 100 0 Exports of Goods and Services (USD bn) (RHS) China 2,500 2,000 6 1,500 4 1,000 2 500 0 0 Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Argentina 10 120 Pickup in exports after currency devaluation in 2002 8 96 -15 -14 Jan -13 Jan -12 Jan -11 Jan -10 Jan -09 Jan -08 Jan -07 Jan -06 Jan -05 Jan -04 Jan -03 Jan -02 Jan -01 Argentine Peso(USD) Jan -00 Jan -99 Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan -98 0 -97 0 -96 24 -95 2 -94 48 -93 4 -92 72 -91 6 Exports of Goods and Services (USD bn) (RHS) Source: IMF, Oanda, World Bank, AlJazira Capital Research 17 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Exchange rate regime indirectly impacts employment levels Emerging markets, particularly Asia, face significant unemployment problems. In such scenarios, countries also resort to exchange rates regime. During high unemployment periods, devaluation of currency to boost exports and production increases demand for labor. Furthermore, high unemployment contributes to lower productivity and exports, as well as higher trade deficit; thus, forming pressures on currency exchange rate in the future. Figure 7 Unemployment rate v/s exchange rates UAE 3.68 5% UAE has maintained its peg within limits without affecting unemployment 3.68 4% UAE Dirham(USD) -13 -12 Jan Jan -11 -10 Jan Jan -09 -08 Jan -07 Jan -06 Jan -05 Jan Jan -04 -03 Unemployment Rates (RHS) South Africa Increasing unemployment rate indirectly leading to fall in exchange rate 14 Jan -02 Jan -01 Jan -00 Jan -99 Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan -98 0% -97 3.67 -96 1% -95 3.67 -94 2% -93 3.67 -92 3% -91 3.68 30% -13 -12 Jan -11 Jan Jan -10 -09 Jan -08 Jan -07 Jan -06 Jan -05 Jan -04 Jan -03 South African Rand(USD) Jan Jan -02 -01 Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan -00 0% -99 0 -98 6% -97 2.8 -96 12% -95 5.6 -94 18% -93 8.4 -92 24% -91 11.2 Unemployment Rates (RHS) Saudi Arabia Saudi Arabia maintained its peg without affecting unemployment 3.77 © All rights reserved 3 n1 2 Ja n1 1 Ja Ja n1 0 n1 9 Unemployment Rates (RHS) Ja n0 8 Ja n0 7 Ja n0 6 Ja Ja n0 5 n0 4 Ja n0 3 n0 Ja Ja n0 n0 Ja Ja n0 n9 Ja n9 Ja Ja n9 n9 Ja Ja n9 n9 Ja n9 Ja Ja n9 Ja n9 Saudi Riyal(USD) 2 0% 1 3.7 0 1% 9 3.71 8 2% 7 3.72 6 3% 5 4% 3.73 4 3.74 3 5% 2 3.75 1 6% Ja 18 7% 3.76 Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Russia Rising unemployment rate indirectly leading to fall in exchange rate 42 14% Russian Ruble(USD) Jan-13 Jan-12 Jan-11 Jan-10 Jan-09 Jan-08 Jan-07 0% Jan-06 0 Jan-05 2% Jan-04 6 Jan-03 4% Jan-02 6% 12 Jan-01 18 Jan-00 8% Jan-99 24 Jan-98 10% Jan-97 30 Jan-96 12% Jan-95 36 Unemployment Rates (RHS) Mexico Rising unemployment rate indirectly leading to fall in exchange rate 16 8% 13 n- Ja 12 n- Ja 11 10 n- n- Ja 09 n- Ja 08 Ja nJa 07 n- Ja 06 05 nJa 04 n- n- Ja 03 Ja nJa 02 n- Ja 01 00 nJa 99 n- n- Ja n- Ja Ja nJa nJa nJa n- n- Ja Ja nJa nJa 98 0% 97 -4 96 2% 95 1 94 4% 93 6 92 6% 91 11 Unemployment Rates (RHS) Mexican Peso(USD) Argentina Falling unemployment rate and stable exchange rates after crisis in 2002 8 6 20% 15% Argentine Peso(USD) 3 2 n1 Ja n1 1 Ja Ja n1 0 9 Ja n1 8 n0 Ja n0 7 Ja n0 6 Ja Ja n0 5 4 Ja n0 3 n0 Ja n0 2 Ja n0 1 Ja Ja n0 0 9 Ja n0 8 n9 Ja n9 7 Ja n9 Ja n9 Ja n9 Ja n9 Ja n9 Ja n9 n9 Ja Ja 6 0% 5 0 4 5% 3 2 2 10% 1 4 Unemployment Rates (RHS) Source: IMF, Oanda, World Bank, AlJazira Capital Research 19 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Currency war intensifies after 2014 Currency war made a comeback from the beginning of 2014. The magnitude of the war can be understood from the turn of events, ranging from the crash of the Russian ruble to devaluation of yen in October 2014 and depreciation of yuan in August 2015, followed by depreciation of the Kazakhstani tenge. Recently, European Central Bank President Mario Draghi announced that if required, the Eurozone could take up another round of quantitative easing. This would further increase the volatility in the currency market. Competitive devaluation, a tool for economic recovery USD appreciated against most major currencies in the past year, led by slow growth in most countries. To increase growth, encourage exports, and discourage imports, the governments of various countries have resorted to currency devaluation. The problem is cyclicality of currency devaluation, as one country devalues its currency, another country follows suit to protect itself and the vicious spiral begins causing a race to the bottom. This phenomenon thus leads to a currency war. Quantitative easing in Japan impacts neighboring countries, particularly China In October 2014, the Bank of Japan announced another round of quantitative easing, indicating its strategy of ‘beggar-thy-neighbor’. Yen depreciated by 10.7% from 108.0 per USD in October 2014 to 119.5 per USD in December 2014. This move impacted China adversely, as it became defenseless when faced with currency war due to yuan’s slow crawling rate against USD. This worsened the situation for China, as the economy was already struggling from slow growth of around 7% (compared with the prior-period growth rate of around 10%). This was one of the reasons China devalued yuan to boost economic growth. Russian ruble, a race to the bottom Many sanctions were imposed on Russia following its conflict with Ukraine. This, coupled with lower oil prices, led to a decline in the value of Russian ruble, as petroleum products constitute around 63% of Russia’s total exports. Ruble declined from 34.4 per USD in June 2014 to around 64.6 per USD in February 2015. Russia also moved toward floating rate regime during this period. However, as most of Russia’s oil exports are contracted in USD, in short term, this would cushion the losses due to weakening oil prices. The dragon enters the war The Chinese economy is weakening in the short term, fueled by declining exports, with exports declining YoY for the last four months. China’s GDP is expected to grow at 6.8% and 6.3% in 2015 and 2016, respectively, lower than its earlier growth rates. Owing to these factors, China allowed Yuan to depreciate 4% against USD. 20 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Kazakhstan follows suit Kazakhstan is among Asia’s largest crude exporters, with crude petroleum constituting 55.0% of its total exports. Russian ruble depreciated from 34.6 per USD in June 2014 to 65.2 per USD in August 2015. Furthermore, yuan also depreciated about 3% in August 2015. China and Russia together account for around 29% of Kazakhstan’s total exports. This led to the goods from the country to be less competitive in the respective markets. Figure 9 Kazakhstan exports by product Figure 8 Kazakhstan exports by country Oth ers % 37 C h i na % 20 Oth ers % 37 R us s i a % T urk ey % I taly % 4 Sw i tz erland % 4 Aus tri a % 4 France % 7 Neth erland 9 9 % C h i na % 7 Source: The Observatory of Economic Complexity, AlJazira Capital Research 20 R us s i a % T urk ey % I taly % 4 Sw i tz erland % 4 Aus tri a % 4 France % 7 Neth erland 9 % 9 7 Source: The Observatory of Economic Complexity, AlJazira Capital Research As the country’s currency is pegged to USD, an anticipation of increase in interest rates in the US led to the appreciation of USD. This increased pressure on the country’s currency peg. Similar to the Argentine crisis, Kazakhstan had to resort to other measures to remain competitive. Therefore, the country resorted to currency devaluation from around 180 Kazakhstani tenge (KZT) per USD to 240 KZT per USD in August 2015. 21 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Figure 10 Currency war after 2014 August 2015 – Chinese yuan devaluation Suffering from low exports and slow growth, China allowed yu an to depreciate around 3% against USD June 2014 – Russian ruble devaluation Ru ssian ruble began falling and lost almost half its value until February 2015, due to weak oil prices and sanctions on the country due to the Ukraine fiasco October 2014 – Japanese yen devaluation The Bank of Japan announced another round of quantitative easing to simulate growth in the economy September 2015 – Possible currency war due to another round of QE ECB announced it may undergo another round of QE if required to simulate growth and avert deflation August 2015 – Kazakhstani tenge devaluation As the country’s major exports were becoming uncompetitive, Kazakhstan devalued tenge by almost 30% Source: AlJazira Capital Research The path ahead Currency devaluation leads to a decline in purchasing power domestically and increases inflation. However, the devaluation provides an immediate boost to the economy’s exports and helps in increasing employment, in addition to reducing trade deficit. This is the primary reason for many countries to use the mechanism during economic crisis. Therefore, we believe, more countries could devalue their currencies as they feel the heat of currency wars from peers globally. Chinese Yuan devaluation China’s journey to a global powerhouse China began its transition to a global powerhouse in 1978, when the country commenced undertaking economic reforms by opening trade with the outside world. China established yuan as its foreign trade currency and renminbi as its domestic currency. The country set up two different prices for state-owned enterprises (SOEs) and private sector goods, with the SOEs receiving lower price advantage. 22 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back In 1980, China became a member of the IMF and the World Bank. The government created four special economic zones in Zhuhai, Xiamen, Shenzhen, and Shantou for encouraging foreign direct investment (FDI). Furthermore, the Chinese government promoted 14 coastal cities and three regions as open areas for foreign investment. These regions enjoy less red tape and tax benefits to attract FDI. In 1986, the government passed General Principles of Civil Law to provide the basic legal principles for operating a market economy. In 1987, the Chinese government recognized private sector as an important factor for economic growth. China slowly began reforming the yuan from 1988. After initially pegging the yuan to USD, China gradually moved toward the managed floating rate regime. The historical timeline presents detailed reforms path for the yuan. Figure 11 Evolution of Yuan from fixed peg to floating 1996 Allowed yuan to be fully convertible under the current account 1988 Semi-official currency swap centers established across China to allow firms to trade yuan 1994 Unif ied dual exchange rates; devalue yuan by 33.0% to 8.7 against USD 2003 Huge trade surplus led to international pressure toallow the yua n ri s e for balancing global trade 2000 Widened the band to 8.2760 –8.2800 against USD 1997-99 Yuan boxed between 8.2770 and 8.2800 for about three years 2001 Joined WTO and pledged to gradually adjust its currency regime 2008 Effectively peg ged yuan to 6.83 against USD 2005 Revalued yuan by 2.1% and shifted to managed floating exchange rate based on reference to a basket of currencies 2004 Announce d gradual move ment toward flexible currency regime 2015 Devalued yuan by about 3% against USD 2010 Resumed reforms for yuan exchange rate and increasing currency flexibility 2009 Began internationalization of yuan 2007 Widened yuan’s daily trading band against USD to 0.5% from 0.3% 2012 Allowed all firms in China to pay for imports and exports in yuan and increase the trading band for theyuan against USD to 1.0% from 0.5% Source: AlJazira Capital Research 23 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Yuan pegged to USD aids in soaring of exports For long, China pegged its currency at a fixed rate, thereby protecting its exporters and encouraging exports. During the period of fixed peg, exports increased exponentially to about USD 2.4tn in 2013 from USD 9.8bn in 1978. Since there are restrictions on the amount of foreign exchange that can be held by a private entity, the foreign exchange reserves soared to USD 3.9tn in 2014 from USD 4.5bn in 1978. China ranks first in the world in terms of foreign exchange reserves, way ahead of developed and developing countries, such as the US (USD 434.4bn), Japan (USD 1,260.0bn), India (USD 325.1bn), and Germany (USD 193.5bn). China has been gradually liberalizing its policies toward floating exchange rate regime (price determined by market forces). Figure 13 Total reserves (USD tn) Figure 12 Total exports (USD bn) 4 2013 C h i na G erm any I nd i a Japan Source: National Bureau of Statistic of China, AlJazira Capital Research 2011 2005 2002 1999 France U ni ted 2014 2011 2009 2007 2005 2003 2001 1999 1997 1995 1993 1991 1985 1978 1978 500 1996 0 1993 1,000 Japan bi a Saud i Ara 1990 1 1987 1,500 1984 2 1981 2,000 0 C h i na 3 2,500 2008 3,000 Saud i Arabi a States Source: World Bank, AlJazira Capital Research The FDI inflows in China have been increasing rapidly after the government began undertaking measures to attract foreign investment in 1980. In 2013, China attracted one of the highest FDI net flows globally, totaling 15.8% of the total global FDI net flow. Figure 14 Net FDI inflow (USD bn) 350 300 250 200 150 100 B raz i l C h i na G erm any I nd i a R us s i an Fed erati on U ni ted States 2013 2012 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1983 1984 1982 1981 1980 1979 50- 1978 0 2011 50 U ni ted K i ngd om Source: World Bank , AlJazira Capital Research 24 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Internationalization − What’s in it for China? China is reforming the yuan in line with its vision to make yuan a global currency by adding it to the SDR basket. This would help China in the following ways: • Reserve currency status would lower the borrowing costs for Chinese companies, in addition to providing more favorable terms and facilitating overseas expansion. • Cross-border contracts in major commodities, such as iron ore, would be priced in yuan, thereby averting foreign exchange risks. • China would be able to use its significant foreign exchange reserves for more economically productive purposes, stimulating economic growth (currently, other reserve currency countries, with much lower reserves relative to their GDP, such as the US, can operate effectively without large reserves). How would internalization of yuan impact the world? To diversify foreign exchange holding, countries consider euro as a key candidate. However, due to uncertainties caused by the Eurozone debt crisis, countries are seeking non-traditional currencies for foreign exchange reserves. Many central banks and global investors are increasingly considering yuan as an alternative. The global impact of internalization of yuan can be summarized as follows: • This would increase demand for yuan by central banks globally and they will be exposed to yuan overnight. • China accounted for around 12.0% of global GDP and 12.0% of global trade, yet the yuan is only used for around 2.0% of global payments. The demand for yuan is expected to increase after being declared a reserve currency. • This increased demand will lead to appreciation of yuan, thereby taking away the competitive export edge away from China. The above turn of events would make imports from China more costly and impact industries (importing low cost goods) globally. • Currently, China settles nearly 22% of its foreign trade in yuan, up from 1% in 2010. However, yuan’s share in global gross foreign exchange market turnover is 2.2% compared with 87.0% for USD, 33.4% for euro, and 23.0% for yen (total volume adds to 200%, as each transaction involves two currencies). Thus, we expect yuan’s use in global trade to increase after the inclusion in the reserve currency. China allowed the yuan to depreciate 3.0% against USD on August 11, 2015. This is mainly because China allowed market forces to determine the price of yuan. Although this step was undertaken basically for protecting China’s own interest, this would help the country fulfill the pre-condition for becoming a world reserve currency. Why did China allow Yuan to depreciate? Depreciation would serve dual purpose for China in the short term; it will help boost economic growth and fulfill the pre-condition for being a world reserve currency. USD appreciated anticipating the US interest rate hike over the past year. Yuan being pegged to USD was also dragged higher, rendering it less competitive. This has hit Chinese exports severely. As the US Federal Reserve is close to increasing its interest rate (the first time in seven years), which indicates further appreciation of USD, the situation could worsen for China. 25 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Figure 16 China GDP growth (%) Figure 15 Total Exports (%) 0. 6 16. 0 % 48 0. 5 14. 0 12. 0 0. 4 10. 0 0. 3 8. 0 % 3- % 3- % 8- Source: National Bureau of Statistic of China, AlJazira Capital Research 2016E 2015E 2014 Jul15- 0. 0 Jun15- May15- Apr15- Mar15- Feb15- Jan15- Dec14- Nov14- Oct14- Sep14- Aug14- Jul14- 4. 0 2. 0 0. 10. 2- 6. 0 2013 0. 0 % 6- 2012 % 15- 2011 % 3 2010 % 5 % 10 2009 % 12 2008 % 15 2007 0. 1 % 9 2006 % 15 2005 0. 2 Source: IMF, World Bank, AlJazira Capital Research The economy is weakening in the short term, fueled by declining exports. China is expected to grow at 6.8% and 6.3% in 2015 and 2016, respectively, lower than its earlier growth rates of about 8–10%. On YoY basis, Chinese exports have declined in the last four months. As the economy is weakening, the central bank did not have to interfere to depreciate the yuan; it can allow the market forces to pull down the currency. Devaluation would render Chinese goods cheaper in the market and encourage exports and discourage local imports, resulting in improved balance of payments. In addition, the People’s Bank of China (PBoC) lowered interest rates by 25 basis points to 4.6%, its fifth interest rate cut since November 2014, to encourage industrial growth. Furthermore, PBoC lowered reserve ratio by 50 basis points for all banks (the fourth cut since February 2015). These measures would help China meet its GDP growth target of 7.0% in 2015. The currency devaluation can be considered an incremental step toward making the currency float freely in the market, a pre-condition for becoming a world reserve currency. The latest changes indicate that PBoC would no longer set the value of the yuan; market forces would determine the value by referring its closing rate on the last day. Global market tumble due to depreciation of yuan As China contributes around 12% to the total world trade, the depreciation of yuan would increase China’s exports. On the other hand, exporters to China would witness a decrease in demand. China imports more than 14% of steel globally and is the largest importer of crude oil globally; therefore, these imports could be impacted. As China depreciated its currency, almost all major stock markets across the globe reacted impulsively and were seen in the red. This was mainly ascribed to some factors listed below: • Chinese oil imports are one of the factors keeping oil prices from falling further. A weaker yuan would lead to lower demand for oil; Prices of commodities may also tumble. • Countries, such as Australia, which experienced an economic boom recently by exporting natural resources, such as iron ore and petroleum, to China (29% of Australia’s exports) will witness a significant slowdown. • Nations from which China imports, such as Japan (10% of China’s total imports), South Korea (9.3%), Other Asia (8.1%), the US (8.0%), and Germany (6.0%), would witness lower demand from the Chinese markets. • Of China’s imports, 14% constitute crude oil. Therefore, we expect a decline in the revenues of oil-exporting countries. 26 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back GCC economies stable enough to weather devaluation of yuan The Chinese yuan policy is expected to have limited impact on trade between GCC countries and China. The recent devaluation is too negligible to impact the oil market and demand for a change in strategy. The Brent prices have dropped over 50% since 2014. Hence, a depreciation of small magnitude in yuan would not majorly impact imports from GCC countries. The Chinese government plans to seize the opportunity of low oil prices by building strategic reserves. China accumulated a surplus of about 41mn barrels in the first five months of 2015 by importing more than required oil for its refineries. We expect demand to be stable in the near future; however, the market of refined products may witness increased competition, as demand for refined products from China may drop. Figure 18 China crude oil imports (mn bpd) Figure 17 China trade statistics 8 250 7. 5 7 150 6. 5 100 6 5. 5 50 Source: Chinese Government stats, AlJazira Capital Research Jul15- Jun15- Apr15- May15- Mar15- Feb15- Jan15- Dec14- Oct14- Nov14- Sep14- p o r t s 4 Aug14- Jul15- Jun15- Apr15- May15- Mar15- Feb15- Jan15- Im 4. 5 Jul14- E x p o r t s Dec14- Nov14- Oct14- Sep14- 5 Jul14- 0 Aug14- USD b n 200 Source: Media research, AlJazira Capital Research Despite the fall in overall imports by China in the last year, oil imports rose to its highest level (7.4mn bpd) in July 2015. China also overtook the US in terms of the volume of crude exports in April 2015. Hence, the GCC countries have not yet bore the brunt of devaluation of yuan. Trade balance to improve marginally As discussed, oil imports from China, which eclipse all other products exported by GCC countries to China, are holding up. On the other hand, GCC countries import considerable amount of non-oil goods from China. Therefore, depreciation of yuan and strengthening of USD would render imports cheaper and improve trade balance in favor of GCC. China’s diversification of oil import destinations had low impact on GCC China has begun diversifying its oil importing sources since early 2014. Imports from GCC, dominated by fuel, accounted for 39.5% of Chinese fuel imports during the first five months of 2014. The share has dropped by 391 bps since the beginning of 2014. The overall imports declined by even higher margins. Hence, the impact of Chinese trade factors on the GCC countries is also reducing, although marginally. 27 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Large assets of GCC countries to peg off currency risk Saudi Arabia and the UAE have sufficient assets to allow them to cope with deficits without abandoning their currency pegs. These countries have enough foreign assets to serve their debt. KSA’s net foreign assets can cover its debt by over 60 times. Kuwait and Qatar are even better placed, led by stronger fiscal positions. Hence, Kuwait and Qatar face the least risk from devaluation of yuan. On the other hand, Bahrain faces the highest risk among the GCC countries. Figure 19 GCC countries net foreign assets (USD bn) and as a percentage of gross debt (as of August) 6036% 712. 9 42% 6. 1 B ah rai n 451% 51. 7 K uw ai t 156% 54% 438% 17. 4 34. 8 Om an Q atar 75. 6 Saud i Arabi a U ni ted Arab E m i rates Source: World Bank, AlJazira Capital Research * Net Foreign Assets is the total foreign assets at the monetary authorities and cash deposits at banks, less obligations to foreign parties We believe that KSA, the UAE, Qatar, and Kuwait are not under any severe pressure to devalue or unpeg their currencies. Cheaper yuan to boost growth in the UAE The move by PBoC to devalue the yuan will benefit the UAE trade balance, as Chinese imports will become marginally cheaper. China accounts for largest share in the UAE imports. As of 2014, China accounted for 11.7% of the total UAE’s imports. The devaluation could ease inflation in the UAE and would benefit trading and logistics companies in the country. On the export side, oil dominates the overall exports and with no sign of decline in oil imports by China, the impact on exports is expected to be minimal. 28 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Figure 20 Country-wise UAE’s import share Figure 21 Country-wise UAE’s export share C H I NA, % 11. 7 U SA, % G C C ,% 22. 8 10. 1 Oth ers , % 40. 4 I NDI A, % 9. 2 I ran, % 14. 4 Oth ers , % 62. 8 G E R MANY % 6. 1 C h i na, I raq , % 3. 1 % 8. 4 JAP AN, % 5. 6 I nd i a, % 14. 0 Source: UAE Government Stats, AlJazira Capital Research Source: UAE Government Stats, AlJazira Capital Research *as of 2014 *as of 2014 The economic impact of devaluation of yuan depends on how the commodity prices (specifically oil prices) and regional economic growth are impacted. Lower oil prices may imbalance global as well as regional economy. China, the largest commodity importer, powered global growth for a while and slowdown in its economy can impact global commodity markets. Hence, export-oriented GCC countries may be impacted, thereby affecting the UAE. GCC accounted for the largest share of UAE exports (22.8%) in 2014. If currency devaluation rekindles growth in China, the UAE will benefit the most. KSA’s exports may contract, but financial stability to provide support to the currency Devaluation of yuan prompted discussions whether KSA would follow the same route and devalue its peg. China’s move has driven other countries, such as Kazakhstan and Vietnam, to follow suit. The move has also triggered a broad sell-off in emerging market currencies. 29 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Figure 22 SAR forward point vs Yuan Figure 23 TASI vs Yuan 9,000 0. 161 8,000 0. 160 0. 158 5,000 0. 157 4,000 0. 156 3. 75 0. 155 3. 74 0. 154 42248 42242 SAR 1 2 M 42236 f o r w a r d 42230 p o in t 42226 42220 0. 153 0. 158 0. 157 0. 156 3,000 2,000 0. 155 1,000 0. 154 0 0. 153 CNY/USD (RHS) TASI Source: Bloomberg, AlJazira Capital Research 42 21 9 3. 76 0. 159 6,000 42 22 5 3. 77 7,000 42 22 9 0. 159 42 23 5 0. 160 3. 78 3. 73 0. 162 0. 161 42 24 1 3. 79 0. 162 42 24 7 3. 80 10,000 CNY/USD (RHS) Source: Bloomberg, AlJazira Capital Research SAMA has enough firepower to defend the currency Saudi Arabia’s foreign exchange reserves stood at SAR 2.5tn in August 2015, equivalent to around 89% of GDP and approximately 40 months of imports. However, a slump in oil prices and rising government expenditure has led to a deficit in government budgeting (the first time since 2011). The reserves also have been declining since hitting the peak value in August 2014 (SAR 2.8tn). Military action on Yemen is also weighing on the government’s spending. However, we expect that increased bond issuances by the government and measures, such as opening up the Saudi stock market to foreigners, would ease the pressure on foreign reserves. The reserves would continue to decline as long as the oil prices remain low, but would be sufficient to defend its currency. Figure 24 Saudi Arabia net foreign assets (SAR bn) 2,781 2,797 2,793 2,784 2,776 2,746 2,754 2,679 2,617 2,574 2,549 2,520 2,508 2,483 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Source: SAMA, AlJazira Capital Research Trade dynamics to be hit China is the largest trade partner of Saudi Arabia, accounting for 12.5% of total exports and 13.4% of total imports. Hence, the devaluation of yuan would render KSA’s imports from China cheaper, but impact the exports. Moreover, if the measures undertaken by PBoC are unable to spur growth in China, the impact could be severe. We expect the trade balance to be marginally hit and the current account balance as a percent of GDP to decline further, but within a sustainable level. Hence, we do not see any imminent pressure on SAR exchange rate or the exchange rate regime followed by Saudi Arabia. 30 © All rights reserved Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back Figure 26 Saudi Current Account Balance Figure 25 Saudi trade statistics (2014) 13.0% 12.7% 13.4% 12.5% 44.1% Imports 5.7% 12.2% 5.0% 3.6% US China Japan Exports 8.9% South Korea 9.6% India Others Source: SAMA, AlJazira Capital Research 31 © All rights reserved %35 %30 %25 %20 %15 %10 %5 %0 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 59.3% 200 180 160 140 120 100 80 60 40 20 0 Current Account Balance (USD bn) as a % of GDP (RHS) Source: IMF, AlJazira Capital Research Currency Wars and its impact on Saudi Arabia Please read Disclaimer on the back APPENDIX Source: Reuter Eikon, AlJazira Capital Research Jul15- May15- Feb15- Source: Reuter Eikon, AlJazira Capital Research Figure 30 USD/ Russian Ruble Figure 29 USD/ Yuan 6.5 80.0 6.4 70.0 60.0 6.3 50.0 6.2 Source: Reuter Eikon, AlJazira Capital Research Jul15- May15- Feb15- Dec14- Oct14- Jul14- May14- Mar14- 0.0 Jul15- May15- Feb15- Dec14- Oct14- Jul14- May14- 10.0 Mar14- 20.0 5.9 Jan14- 30.0 6.0 Jan14- 40.0 6.1 5.8 Dec14- Jul15- May15- Feb15- Dec14- Oct14- Jul14- May14- Jan14- 0.6 Mar14- 0.7 Jul14- 0.8 May14- 0.9 Mar14- Figure 28 USD/ Yen 130.0 125.0 120.0 115.0 110.0 105.0 100.0 95.0 90.0 85.0 80.0 Jan14- Figure 27 USD/ Euro 1.0 Oct14- Appendix − Exchange rates post 2014 Source : Reuter Eikon, AlJazira Capital Research Figure 31 USD/ Kazakhstan Tenge (KZT) 260.0 240.0 220.0 200.0 180.0 160.0 140.0 120.0 32 Jul15- May15- Feb15- Dec14- Oct14- Jul14- May14- Mar14- Jan14- 100.0 Source: Reuter Eikon, AlJazira Capital Research © All rights reserved RESEARCH DIVISION AGM - Head of Research Abdullah Alawi +966 11 2256250 [email protected] Analyst Sultan Al Kadi +966 11 2256115 [email protected] +966 11 2256374 [email protected] General manager - brokerage services and sales AGM-Head of international and institutional AGM- Head of Western and Southern Region Investment Centers & ADC Ala’a Al-Yousef brokerage Brokerage +966 11 2256000 [email protected] Luay Jawad Al-Motawa Abdullah Q. Al-Misbani +966 11 2256277 [email protected] +966 12 6618400 [email protected] AGM-Head of Sales And Investment Centers AGM-Head of Qassim & Eastern Province AGM - Head of Institutional Brokerage Central Region Abdullah Al-Rahit Samer Al- Joauni Sultan Ibrahim AL-Mutawa +966 16 3617547 [email protected] +966 1 225 6352 [email protected] Jassim Al-Jubran +966 11 2256248 [email protected] BROKERAGE AND INVESTMENT CENTERS DIVISION RESEARCH DIVISION Talha Nazar Analyst +966 11 2256364 [email protected] AlJazira Capital, the investment arm of Bank AlJazira, is a Shariaa Compliant Saudi Closed Joint Stock company and operating under the regulatory supervision of the Capital Market Authority. AlJazira Capital is licensed to conduct securities business in all securities business as authorized by CMA, including dealing, managing, arranging, advisory, and custody. AlJazira Capital is the continuation of a long success story in the Saudi Tadawul market, having occupied the market leadership position for several years. With an objective to maintain its market leadership position, AlJazira Capital is expanding its brokerage capabilities to offer further value-added services, brokerage across MENA and International markets, as well as offering a full suite of securities business. 1. RATING TERMINOLOGY Senior Analyst 2. 3. 4. Overweight: This rating implies that the stock is currently trading at a discount to its 12 months price target. Stocks rated “Overweight” will typically provide an upside potential of over 10% from the current price levels over next twelve months. Underweight: This rating implies that the stock is currently trading at a premium to its 12 months price target. Stocks rated “Underweight” would typically decline by over 10% from the current price levels over next twelve months. Neutral: The rating implies that the stock is trading in the proximate range of its 12 months price target. Stocks rated “Neutral” is expected to stagnate within +/- 10% range from the current price levels over next twelve months. Suspension of rating or rating on hold (SR/RH): This basically implies suspension of a rating pending further analysis of a material change in the fundamentals of the company. Disclaimer The purpose of producing this report is to present a general view on the company/economic sector/economic subject under research, and not to recommend a buy/sell/hold for any security or any other assets. Based on that, this report does not take into consideration the specific financial position of every investor and/or his/her risk appetite in relation to investing in the security or any other assets, and hence, may not be suitable for all clients depending on their financial position and their ability and willingness to undertake risks. It is advised that every potential investor seek professional advice from several sources concerning investment decision and should study the impact of such decisions on his/her financial/legal/tax position and other concerns before getting into such investments or liquidate them partially or fully. The market of stocks, bonds, macroeconomic or microeconomic variables are of a volatile nature and could witness sudden changes without any prior warning, therefore, the investor in securities or other assets might face some unexpected risks and fluctuations. All the information, views and expectations and fair values or target prices contained in this report have been compiled or arrived at by Aljazira Capital from sources believed to be reliable, but Aljazira Capital has not independently verified the contents obtained from these sources and such information may be condensed or incomplete. Accordingly, no representation or warranty, express or implied, is made as to, and no reliance should be placed on the fairness, accuracy, completeness or correctness of the information and opinions contained in this report. Aljazira Capital shall not be liable for any loss as that may arise from the use of this report or its contents or otherwise arising in connection therewith. The past performance of any investment is not an indicator of future performance. Any financial projections, fair value estimates or price targets and statements regarding future prospects contained in this document may not be realized. The value of the security or any other assets or the return from them might increase or decrease. Any change in currency rates may have a positive or negative impact on the value/return on the stock or securities mentioned in the report. The investor might get an amount less than the amount invested in some cases. Some stocks or securities maybe, by nature, of low volume/trades or may become like that unexpectedly in special circumstances and this might increase the risk on the investor. Some fees might be levied on some investments in securities. This report has been written by professional employees in Aljazira Capital, and they undertake that neither them, nor their wives or children hold positions directly in any listed shares or securities contained in this report during the time of publication of this report, however, The authors and/or their wives/children of this document may own securities in funds open to the public that invest in the securities mentioned in this document as part of a diversified portfolio over which they have no discretion. This report has been produced independently and separately by the Research Division at Aljazira Capital and no party (in-house or outside) who might have interest whether direct or indirect have seen the contents of this report before its publishing, except for those whom corporate positions allow them to do so, and/or third-party persons/institutions who signed a non-disclosure agreement with Aljazira Capital. Funds managed by Aljazira Capital and its subsidiaries for third parties may own the securities that are the subject of this document. Aljazira Capital or its subsidiaries may own securities in one or more of the aforementioned companies, and/or indirectly through funds managed by third parties. The Investment Banking division of Aljazira Capital maybe in the process of soliciting or executing fee earning mandates for companies that is either the subject of this document or is mentioned in this document. One or more of Aljazira Capital board members or executive managers could be also a board member or member of the executive management at the company or companies mentioned in this report, or their associated companies. No part of this report may be reproduced whether inside or outside the Kingdom of Saudi Arabia without the written permission of Aljazira Capital. Persons who receive this report should make themselves aware, of and adhere to, any such restrictions. By accepting this report, the recipient agrees to be bound by the foregoing limitations. Asset Management | Brokerage | Corporate Finance | Custody | Advisory Head Office: King Fahad Road, P.O. Box: 20438, Riyadh 11455, Saudi Arabia، Tel: 011 2256000 - Fax: 011 2256068 Aljazira Capital is a Saudi Investment Company licensed by the Capital Market Authority (CMA), license No. 07076-37