Saudi Arabia's currency misalignment and international competitiveness, accounting for geopolitical risks and the super-contango oil market

Abstract

It is important to assess Saudi Arabia's economic performance, because its role in the global oil market and how its actions are perceived by international investors have global consequences. We study Saudi Arabia's global competitiveness, accounting for geopolitical risks, productivity, and the role of oil as a commodity and financial asset. We use the net cost-of-carry to capture the oil market risk premium and the super-contango oil market, and include military funding and government expenditure to account for anticipatory and reactive military funding in dealing with likely internal and external threats. Following Clark and MacDonald (1999, 2004) and Fidora et al. (2020), we develop a vector error correction model (VECM) that accurately reflects Saudi Arabia's economy and employ a behavioral equilibrium exchange rate (BEER) to estimate currency misalignment as a measure of international competitiveness. We find that domestic productivity is Saudi Arabia's weakness. Rather than being driven by endogenous productivity, Saudi Arabia's competitiveness is largely explained by exogenous factors: global demand for oil as both a commodity and a financial asset, and geopolitical events that diminish competition in the global oil market. Favorable oil market conditions are advantageous, but super-contango episodes are detrimental to the Saudi economy. Saudi Arabia's competitiveness and recovery from the 2020 shocks hinge on the recovery of global demand, the speed of the energy transition, and investors' sentiments to invest in the oil sector. By engaging in trade wars, Saudi Arabia risks accelerating how quickly its own resources and assets become stranded. The 2020 cooperation between OPEC+ and G20 members to stabilize the oil market is commendable, because it will positively impact the global recovery in 2021–2022.