UPDATE 1-Saudi riyal forwards crash through key 1000 level to hit record low

* One-year dollar/riyal forwards hit record high

* Oil nearing $30 a barrel causing jitters

* Many bankers still think devaluation very unlikely

* CDS for Gulf countries hit fresh highs (Adds CDS levels, context, quotes)

By Archana Narayanan and Karin Strohecker

DUBAI/LONDON, Jan 12 (Reuters) - The Saudi Arabian riyal hit a record low in the forwards market on Tuesday, breaching the key 1000-point mark as a fresh slip in oil prices raised fears that the kingdom will eventually scrap or loosen its currency peg to the U.S. dollar.

One-year dollar/riyal forwards - contracts used by counterparties to lock in a future exchange rate - climbed as high as 1020 points in very volatile trade. This topped their previous record of 850 points hit during a bout of speculation against the riyal in 1999, according to Thomson Reuters data.

The move has come despite comments from Saudi Arabia’s central bank governor on Monday that recent volatility in the forwards market is due to speculation based on unrealistic expectations. He restated policy makers’ commitment to the peg.

“Forwards are moving higher on speculation that Saudi Arabia may soon have to either abandon, or at the very least loosen its currency’s peg to the dollar, as its reserves will dramatically fall if oil prices continue to slide further,” said a currency trader at a major Gulf bank.

The riyal is pegged in the spot market at 3.75 to the dollar. Some banks and funds use the forwards market to hedge against the risk that the peg might eventually be broken.

Persistently low oil prices have raised fears that the world’s top oil exporter may have to run down its foreign assets - still totaling $628 billion at the end of December - at a much faster rate than the $100 billion used in 2015 to cover a record state budget deficit, forecast for this year to be 326 billion riyals.

The low crude prices have inflicted much pain on the kingdom’s petroleum industry, which in 2015 generated some 80 percent of government revenues.

Fuelling speculation further are geo-political concerns over a sharp deterioration in relations between Saudi Arabia and Iran in recent days, which is seen likely to continue.


Despite the bleak forecast for oil prices and geopolitics, many bankers still believe Riyadh remains very unlikely to break its currency peg.

“The core Gulf USD pegs, including that of Saudi Arabia, are likely to hold at current oil prices,” said Jean-Michel Saliba, economist at Bank of America-Merrill Lynch in a note to clients.

This was due to a combination of some GCC countries still holding sizeable foreign assets and the start of a fiscal adjustment process across the region based on the understanding that the underlying cause of macro imbalances are unsustainable fiscal positions, he added.

“Oman is the most vulnerable, in our view,” said Saliba.

The Gulf countries’ pegs to the dollar have helped keep inflation low, simplify trade and financial transactions, and reduce uncertainty about the domestic value of oil export receipts.

Those believing the peg will be retained point to economic reforms announced as part of Saudi’s state budget for 2016 at the end of December, which contained steps designed to bring a budget deficit under control including reduced subsidies and the privatisation of state-owned assets.

The sale of a stake in national oil giant Saudi Aramco or some of its downstream companies has also been floated in the last few days.

“The last budget and statements re-enforce the view that Saudi Arabia will focus on fiscal consolidation which will be used to undertake the adjustment to cheap oil rather than a devaluation,” said Jason Tuvey, Middle East Economist at Capital Economics in London.

Yet the recent slide in oil to a near 12-year low and $30 per barrel is weighing heavily on sentiment against crude exporters, with the cost of insuring their sovereign debt against default jumping to fresh highs.

Saudi Arabia’s five-year credit default swaps (CDS) rose by 7 basis points from Monday’s close to 196 bps, matching 6-1/2 year high hit last week, according to financial data provider Markit.

Qatar’s 5-year CDS also jumped 8 bps to 112 bps on Tuesday, the highest since summer 2012, and Bahrain added 9 bps to hit 393 bps, the highest level since February 2012. (Editing by Raissa Kasolowsky)