* One-year dollar/riyal forwards hit record high
* China yuan drop fuels speculation over riyal
* Many bankers still think devaluation very unlikely
* Foreign reserves enough to keep defending riyal for years
* But Riyadh may have to cut spending more as economy slows (Updates with new low for riyal, analysis)
By Andrew Torchia and Archana Narayanan
DUBAI, Jan 7 (Reuters) - The Saudi Arabian riyal hit a record low against the dollar in the forwards market on Thursday as sliding oil prices caused some international banks and funds to bet the kingdom may eventually be pushed into devaluing its currency.
One-year dollar/riyal forwards climbed as high as 900 points in very volatile trade, exceeding their previous record of 850 points hit during a previous bout of speculation against the riyal in 1999, according to Thomson Reuters data.
A level of 900 points implies depreciation of the riyal of 2.3 percent over the next 12 months. The riyal has been pegged in the spot market at 3.75 to the dollar since 1986, but confidence in the peg has been waning for several months.
“Forwards are moving higher as the market prices in a devaluation of the riyal against the dollar,” said a currency trader at a major Gulf bank, adding that Saudi banks were not supplying enough dollars to the market to meet demand.
“Also, there is panic in stock markets across the GCC (Gulf Cooperation Council) - this is adding to pressure on the currency in both spot and forward markets.”
The Saudi stock index sank 4.5 percent to its lowest level since December 2011 and other Gulf markets fell sharply on Thursday because of the fresh slide in oil prices and worries about the regional and global economies.
China’s decision to allow the biggest fall of the yuan against the dollar in five months on Thursday added to the speculation against the riyal.
Low oil prices are undermining the confidence of international investors in the ability of the world’s top oil exporter to continue growing its economy over the long run.
The central bank, which serves as the kingdom’s sovereign wealth fund, has been running down its foreign assets at an annual rate of over $100 billion to cover a huge state budget deficit as oil revenues shrink.
Many bankers in the Gulf believe Riyadh remains very unlikely to break its currency peg. They note that foreign assets still totalled $628 billion at the end of December - enough to keep defending the riyal for years.
They also see a risk that the Saudi central bank could intervene in the forwards market to punish speculators, as it did during two bouts of speculation against the riyal in the 1990s.
A devaluation “will only be used as a last resort”, London-based Capital Economics said in a report on Thursday. Riyadh would rather cut its spending further than risk a burst of inflation with a weaker currency, a potential political danger, it said.
The state budget for 2016, released last week, contained austerity steps designed to cut the deficit and reduce pressure on foreign assets. However, the budget assumed an average oil price of about $40 a barrel, analysts believe. Saudi Arabia does not publish the oil price on which its budgets are based.
If Brent crude stays around its current level of $33, or falls further, the government may face a tough choice: accelerate depletion of its foreign reserves, which could alarm the markets, or cut spending at a time of slowing economic growth.
A corporate purchasing managers’ survey published on Thursday showed growth in Saudi Arabia’s non-oil private sector in December falling to its slowest pace since the survey was launched in August 2009. (Editing by Raissa Kasolowsky)