(Bloomberg) -- Saudi Arabia’s economic downturn is about to worsen. Already reeling from the slump in oil prices and lockdowns to halt the spread of the coronavirus, the kingdom has now increased taxes and cut spending.
While the government says overall expenditure will remain broadly in-line with the 1 trillion riyals ($266 billion) outlined in the 2020 budget, tripling value-added tax and cutting bureaucrats’ allowances will damage consumption and hurt the private sector that is key to Crown Prince Mohammed Bin Salman’s vision to diversify the economy away from oil.
And while raising VAT should help rein in a widening budget deficit, it will make the country less competitive than other Gulf states when it’s trying to attract more foreign investment.
“These are radical measures that underscore the gravity of the challenges facing the kingdom,” said James Reeve, group chief economist at Samba Financial Group. “The measures send a message to the markets that the authorities are prepared to make tough choices to keep the deficit within bounds. The downside is that this is a further blow to the already stricken retail sector.”
The shift, announced early Monday by Finance Minister Mohammed al Jadaan, has forced analysts to cut their growth projections for the Arab world’s biggest economy for a second time in just a few weeks. Samba’s Reeve has slashed his 2020 forecast and estimates growth will drop 3.7%, while JPMorgan Chase & Co.’s Giyas Gokkent now thinks his expectation of an overall contraction of 3% is too optimistic. Standard Chartered Plc’s Bilal Khan revised his estimate to a 5% fall.
Saudi Arabia’s finances have been battered by a more than 50% slump in crude prices this year. The commodity still makes up the majority of government revenue four years into Prince Mohammed’s overhaul of the economy. Coupled with a strict curfew to contain the coronavirus, the kingdom is set for its deepest financial turmoil in decades.
Foreign reserves, key to guarding the riyal’s peg to the dollar, dropped by a record $27 billion in March, when Saudi Arabia accelerated oil’s slide by engaging in a price war with Russia.
With no appetite to devalue the currency, and pressure to contain a deficit the International Monetary Fund predicts will hit around 13% of output this year, the kingdom has limited options. It has already raised about $20 billion from international and domestic debt markets since the end of 2019. Al Jadaan said the government does not intend to borrow more than the 220 billion riyals it had previously announced for 2020, indicating its focus will be on containing the budget gap.
“We want to make sure that we maintain our fiscal strength so that as the economy gets out of the lockdown, we are able to support the economy,” he said.
The next few months will test the wisdom of an approach described by Tarek Fadlallah, head of Nomura Asset Management’s Middle East unit, as “kitchen-sinking a lot of tough measures.”
In a region that has built most of its industry outside of oil on the back of low taxes and cheap foreign labor, the challenge for Saudi Arabia will be remaining competitive against neighbors with much lower VAT and other rates. Some, such as the United Arab Emirates and Qatar, also have better infrastructure and allow expatriates more social freedoms.
“The government is using this crisis to push through necessary cuts to the public sector wage bill, which will be positive over the longer term,” said John Sfakianakis, director of economic research at the Gulf Research Center. “But raising VAT will hit consumption and hurts competitiveness.”
It’s also a political gamble for Prince Mohammed, who reversed course after previous attempts to reduce public wages caused grumbling among citizens. The kingdom has long used its oil wealth to maintain generous state benefits, such as subsidized fuel prices and scholarships.
The government will likely watch Saudi reactions closely and could change tack if there’s pushback. During and after the last oil price rout of 2014-16, several austerity measures were repealed or eased after a backlash. In 2017, seven months after the government cut a slew of allowances for public sector workers, they were reinstated. While officials said that was because the government’s finances had improved, the decision was announced soon after calls for protests surfaced on social media.
“Although unpopular, the government will be keen to stress to the population these measures are necessary for a more sustainable economic model,” said Rachna Uppal, a senior analyst at political risk consultancy Castlereagh Associates. “The measures are far reaching and will hit Saudis at a time when many businesses are already struggling amid severely restricted economic activity.”
Today, even if citizens privately complain about the impact on their wallets, they’re less likely to do so publicly. That’s partly due to rising levels of nationalism, and partly because of a climate of fear that’s arisen as the government stifles domestic dissent.
If the economy “needs part of our money,” citizens should give it without hesitation, Saudi economic consultant Ahmed Alshehri wrote on Twitter on Monday. “All of the things that are being done now are 100% economically appropriate.”
After spending much of March and April pumping more oil, Saudi Arabia is now reversing course. It announced on Monday a reduction of 1 million barrels a day for June, which will bring total production cuts from April to 4.8 million barrels. Crude prices spiked on the news, before paring gains.
Just five years ago, taxation was almost unthinkable for Saudi Arabia. But the 2014 oil price rout spurred Prince Mohammed to change the economic model as he rose to power. Under his “Vision 2030” plan, the government has cut energy subsidies, added new taxes and fees and called on the private sector to take the lead in developing the country.
“There was always going to be a period when the pain needed to be felt,” said Nomura’s Fadlallah. “There are bound to be complaints, but the government seems to be taking view that they can ride it out.”
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