Economy

Saudi Arabia's austerity drive seen as 'decisive and necessary,' but could delay a consumer recovery

Key Points
  • The kingdom will triple VAT from 5% to 15% in July, suspend its cost of living allowance for public sector workers, and cut and delay projects part of Vision 2030.
  • The fiscal measures come as the entire Gulf region is reeling from the double blow of global lockdowns and the lowest oil prices in two decades.
A picture taken on March 26, 2020, shows a car driving on a road next to the King Abdullah Financial City in the Saudi capital Riyadh, after the Kingdom began implementing an 11-hour nationwide curfew, on the day of an emergency G20 videoconference, to discuss a response to the COVID-19 crisis. (Photo by FAYEZ NURELDINE / AFP) (Photo by FAYEZ NURELDINE/AFP via Getty Images)
FAYEZ NURELDINE | AFP via Getty Images

Saudi stocks dipped on Monday during the Tadawul's morning trading hours on the news of the kingdom's unprecedented austerity measures meant to contain the budget deficit amid the oil price crash and coronavirus crisis.

The fiscal measures come as the entire Gulf region is reeling from the double blow of global lockdowns and the lowest oil prices in two decades.

The kingdom will triple value-added tax (a sales tax known as VAT) from 5% to 15% in July, suspend its cost of living allowance for public sector workers, and cut and delay projects part of Vision 2030, the multi-billion dollar initiative aimed at diversifying and reforming the Saudi economy. Total government spending cuts amount to 100 billion riyals ($26.6 billion), or roughly 10% of total expenditure from the original 2020 national budget.  

"With the oil price required for the budget to balance at just under USD80/barrel in 2020, these bold, decisive and necessary austerity measures are paramount to prevent a rapid deterioration of wealth buffers," said Ehsan Khoman, head of MENA research and strategy at MUFG Bank in Dubai.

Brent crude is currently trading at roughly $30 per barrel, down more than 50% year-to-date and less than half of what Saudi Arabia needs to balance its budget.

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Still, the pain will be lasting, fiscal deficits will remain wide and demand will stay depressed for the foreseeable future, a reflection of the rest of the world amid the global pandemic and worst economic downturn in memory. The cost-cutting and revenue enhancing measures — while deemed necessary — may slow any eventual bounce-back. MUFG forecasts a domestic demand contraction of more than 4% for this year. 

"Further cuts to capital spending by the government will weigh on non-oil sector activity this year and probably next year as well, as government spending remains a key driver of non-oil activity despite efforts to diversify the economy," Khatija Haque, head of MENA research at Dubai-based Emirates NBD, wrote in a research note Monday.

"Raising VAT when many households are already facing job losses and salary cuts is likely to exacerbate the decline in consumption this year and increase pressure on businesses." 

It's also likely to delay a recovery in spending for the kingdom in 2021, Haque wrote.

Buffered by strong currency reserves

Finance Minister Mohammed al-Jadaan told media the VAT increase is intended to help shore up government finances in the coming years, though little impact is expected for 2020 given that business activity and consumption is for the most part halted in the efforts to fight the coronavirus. There is therefore very little in the way of non-oil revenues for the tax increase to boost. 

Tripling VAT when neighboring Gulf economies like Kuwait and the UAE still have VAT at 5% could also make those destinations "marginally more competitive," Haque wrote, though it's yet to be seen whether they will follow Saudi Arabia's lead. 

Saudi Arabia is considered the most economically well-buffered of the GCC countries, with more than $470 billion in foreign reserves as of March, by far the highest in the Middle East and among the top 10 globally in terms of reserves. Reserves fell by $24 billion in March, the largest monthly drop on record.

Khoman sees the kingdom's decisive moves as a positive sign. "We continue to take increasing comfort with the lengths and vigour that the authorities are demonstrating in providing forward guidance to markets in articulating their policy responses to tackle the oil-virus shocks," he said. "As such, although the broad commitment to reform remains in place, there appears to be a realistic rethinking of several aspects of the development plan to ensure robust execution."

MUFG forecasts a fiscal deficit of 15.2% of gross domestic product. The original deficit outlined in the kingdom's initial 2020 budget was 6.7%, at the time the largest in its history. If the 100 billion riyal spending cut is carried out, Emirates NBD estimates a slightly smaller budget deficit of 13% for 2020 — still about double what was initially planned for this year.

The kingdom in late March rolled out a 70 billion riyal stimulus package to help small and medium-sized businesses, while reallocating resources to health care and other sectors deemed essential. In April it unveiled a 50 billion riyal package to fast-track payments owed to the private sector and a 30% discount on electricity bills for two months for industrial, agricultural and commercial sectors. 

"We are facing a crisis the world has never seen the likes of which in modern history," al-Jadaan said in a statement. "These measures that have been undertaken today, as tough as they are, are necessary and beneficial to maintain comprehensive financial and economic stability on the medium and long-term for the interest of the country and its citizens."