Abstract

This paper attempts to measure degree of misalignment of the Saudi Riyal by estimating the long run equilibrium real exchange rate of the currency. Based on cointegration technique, this paper has identified, government consumption expenditure, GDP growth and gross capital formation as important determinants of the Saudi Riyal long run equilibrium value. Results suggest that the actual real exchange rate was below the estimated equilibrium (Saudi Riyal over valued) in 1980,198 1and 1982 by 25%, 16% and 7% respectively. Following 1983, the Saudi real exchange rate rose above the equilibrium exchange rate thus starting an era of undervaluation of the Saudi currency that lasted until the year 2009.The downward slide began in 1983 when the riyal fell below its equilibrium exchange rate by 1% with the declining trend deteriorating further to 10% in 1984, 19% percent in 1985, 27% in 1986 and so on until it hit an all-time low of 84 percent below estimated equilibrium in 2006. Thereafter, the decline started receding gradually with the misalignment below exchange rate equilibrium improving to about 80 percent in 2009.

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