Sheikhing the Money Tree: Saudi Arabia triples VAT to raise finances mid-pandemic

May 23, 2020

2 min read

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What's going on here?

The kingdom of Saudi Arabia, as part of a series of austerity measures, has increased VAT from 5% to 15%

What does this mean?

The new VAT rate, introduced in the kingdom only in 2018, remains below the UK’s – 20%.  An indirect tax, VAT is charged on any goods or services collected by a producer or retailer, with the cost passed onto the consumer.  Other examples of indirect taxes are cigarette and “sugar tax” levies.  Income tax is an example of a direct tax.  

Alongside VAT, a cost of living allowance, paid monthly, had been introduced for 1.5 million Saudi government employees, designed to compensate for hiked domestic gas prices.   This has now been suspended.  The finance minister commented both measures were “painful” but “necessary for economic stability”.  

The pandemic has precipitated a demand shock for oil globally, causing prices to plummet at unprecedented rates (read our article here).  The subsequent pressure on Saudi public finances – still dependent on oil for 80% of its state revenues – has run up a budget deficit of £9bn in 1Q2020.  In March alone, revenues fell 24% (compared to March 2019) and the kingdom made the largest ever withdrawal from its foreign reserves ($23bn), taking it to its lowest levels since 2011.

What's the big picture effect?

On April 10, Saudi-led OPEC+ (Organisation of the Petroleum Exporting Countries and allies including Russia) announced plans to cut production by 7m barrels a day.  The agreement, valid until April 2022, signalled the halting of a bitter oil war between the kingdom and Moscow.  Last week, WTI (West Texas Intermediate), the US benchmark, jumped 25% while Brent crude, the international benchmark, rose 17%.  Concerns remain whether the measures are sufficient to stabilise the market in the long term.  

The kingdom’s domestic political legitimacy rests on divesting its dependence from oil.  The kingdom last year sold shares in state-owned oil giant Aramco.  The IPO (initial public offering) for the world’s largest oil producer raised nearly $26bn (read our articles here and here).  The kingdom’s Public Investment Fund (PIF) is also expected to gain an 80% stake in the £300m takeover of Newcastle United, subject to approval by the Premier League.  In the meantime, Saudi Aramco has entered talks with banks to borrow $10bn to finance a stake in SABIC (Saudi Basic Industries Corp), a multinational chemical manufacturer that converts oil by-products.  Cuts of $27bn to its Vision 2030 program risks jeopardising further economic reforms.  

The future of the kingdom, the world’s largest exporter of oil, remains uncertain.  The kingdom risks being stuck in a catch-22 scenario, with its own austerity measures curtailing plans to modernise the economy and reduce its dependence on oil

Report written by Sophie Belcher

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