SAUDI: Tripling the VAT is a bold move that will facilitate reforms in other states
Saudi Arabia has announced new fiscal consolidation totalling $27bn (4% of GDP), including spending cuts, ending a key benefit for public sector employees and tripling the VAT to 15%. These will help significantly with fiscal consolidation, particularly in 2021, but at the cost of further contraction of the non-oil economy and the risk of social unrest. Still, the reforms go beyond our base assumptions and are credit positive. They should also facilitate reforms elsewhere in the GCC, particularly in the fiscally weaker states, with Bahrain likely to move more quickly than Oman in implementing changes.
The wording of the release was a little ambiguous but seems to price the full package at around SR100bn ($26.7bn, about 4% of GDP) of consolidation for the 2020 fiscal year. Assuming this is the case it will significantly bring down deficits, with the spending cuts having a temporary impact that might be offset by increases in subsequent years when delayed projects restart, but with the VAT and transfer changes providing lasting fiscal consolidation. We still expect very large deficits for the next few years, and achieving anything like a fiscal balance will still be difficult medium-term if oil remains low for long, presenting long-term challenges to Saudi Arabia’s economic model and credit rating. However, the consolidation, if it holds, may be enough to postpone further negative rating actions in the near future, following Moody’s negative outlook announced last week. It’s worth remembering that previous fiscal consolidation measures have been rowed back in the past after complaints - benefit cuts introduced after the 2015 oil crash were subsequently paid back, and in 2019 the tax on companies for expat workers was suspended for manufacturing firms, and increases in rates put on hold for other sectors. This could be repeated, although we think backsliding is less likely this time, given the intensity of the crisis, unless there is an unexpected rebound in oil prices.
The impact of the Saudi moves could reverberate across the region. For starters, those countries with a VAT in place - UAE and Bahrain - will need to consider whether to match the Saudi increase.
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