Saudi Arabia Unveils Austerity Program, Including Tripling Of VAT, To Fight Coronavirus Impact

The kingdom of Saudi Arabia has introduced an austerity program to deal with low crude oil prices and the ravages of the coronavirus pandemic.

Under the scheme, the government will triple its value-added tax, or VAT, from 5% to 15%, effective July 1, and stop making monthly cost of living allowance payments to its public sector employees beginning in June.

The monthly allowance of 1,000 riyals ($266) per month to state employees was first introduced in 2018 to compensate for increased financial obligations, including VAT and the rising cost of living.

About 1.5 million Saudis are employed by the state.

"These measures are painful but necessary to maintain financial and economic stability over [the] medium to long term... and overcome the unprecedented coronavirus crisis with the least damage possible," said finance minister Mohammed al-Jadaan.

Moreover, the Saudi central bank's foreign reserves dropped in March at the fastest rate in at least two decades.

"The economy of Saudi Arabia has been under a lot of stress. That’s why the government withdrew $23 billion from the reserve in March,” said Ali al-Ahmed, an expert on Saudi political affairs at the Institute for Gulf Affairs in Washington. “This is the largest withdrawal from the reserve, ever, in the history of the country,"

The government also said it is "cancelling, extending or postponing" expenditures for some government agencies and slashing spending on some major state projects. As a result, the kingdom’s long-cherished plans to diversify the economy away from petroleum will be temporarily shelved.

Jadaan added: “All these challenges have cut state revenues, pressured public finances to a level that is hard to deal with going forward without affecting the overall economy in the medium to long term, which requires more spending cuts and measures to support non-oil revenues stability."

Due to slumping crude prices, oil revenues plunged 24% in the first three months of the year.

Jadaan warned that the kingdom may lose half of its oil income this year -- cash that accounts for about 70% of public revenues. He further said the government will borrow nearly $60 billion this year to help close a huge budget deficit.

In the first quarter of 2020 alone, the kingdom incurred a $9 billion budget deficit.

“I believe this [austerity program] is important for the government to manage its finances,” said Shailesh Dash, board member at Allied Investment Partners. “Lower oil prices would have significantly impacted the budgetary needs of the country and maintaining the right fiscal discipline. In the short term -- because of COVID-19 and slowdown in businesses -- this would have a very big impact on local business houses and trading activities.”

To prevent the spread of the virus in the country, Saudi Arabia has closed cinemas and restaurants, banned air flights, and suspended the year-round Umrah pilgrimage to Mecca.

In April, the International Monetary Fund estimated that the Saudi economy would shrink by 2.3% this year.

For Saudi consumers, the increase VAT will pressure their pocketbooks.

“Even if the duty amount is tolerable, the VAT, which is a direct tax, will have an enormous effect on the price of landed goods,” said Thomas Gregory, executive director at Fusion Specialized Shipping & Logistics in UAE. “Along with duties, the landed cost [the total price of a product or shipment once it arrives at the buyer] is going to be costlier by 20%. The direct impact of VAT on exports will not be a significant impact as most services are exempted.”

Gregory added delivery costs will also rise.

“Local moves will be impacted big time as the VAT component has increased by 300%,” he said. “For example, if a local move costs 500 Saudi riyals, with the new VAT rules, it could cost 575 riyals. With companies working at a 10%-12% margin, this could be seen as a step that will increase product prices. Customers may refrain from buying non-essentials and luxury goods, but essential commodities must move. Logistics is a derived demand, hence there will not be a significant impact on the industry. It is a matter of time to get accustomed to the new realities of life.”

The VAT hike will likely push up inflation in the kingdom.

“The burden of VAT is generally borne by the consumer and so it is expected that Saudi Arabia will experience price inflation,” said Joanne Clarke, tax director for Pinsent Masons in London. “[There will be a] reduction of spending on luxury items as consumers’ disposable income becomes less valuable in the region. Businesses undertaking exempt activities in Saudi Arabia and unregistered businesses will also feel the impact of the VAT rate increase on their profits.”

In Saudi Arabia, the number of coronavirus infections climbed to 39,048 as of Sunday. About 250 people have died from the virus.

Gulf News reported that Saudi Arabia’s sudden spike in VAT could lead to similar measures in the neighboring United Arab Emirates and Bahrain, where the VAT remains at 5%.

“Several business sectors had submitted requests to the UAE authorities for a six-month VAT holiday until things get back to normal and consumers regain their confidence,” said the chief of an industry group in Dubai. “The Saudi announcement comes as a complete jolt, and it will be difficult for consumers to sustain the tripling of VAT.”

UAE introduced VAT on Jan. 1, 2018, while Bahrain followed suit one year later. In 2018, the tax generated revenues of $7.35 billion for UAE coffers.

If the UAE raises its VAT, it is not expected to jump as high as the 15% rate to be slapped by the Saudis. For now, UAE said it has no plans to hike VAT.

In the event UAE maintains is 5% VAT, it could provide advantages for local businessmen and consumers.

“It’s unclear what the quantifiable advantages will be for cross-border transactions,” said Sameer Lakhani, managing director at Global Capital Partners. “But on the surface, it does appear that certain 'arbitrage' opportunities might open up if there are differences in VAT rates.”

Dash of Allied Investment Partners said he is confident the UAE will hold its VAT steady.

"I don't think [a hike] is a possibility at the moment," he said.