ASG Analysis: Sweeping Austerity Measures in Saudi Arabia
- Yesterday (May 10), Saudi Arabia announced an unprecedented slew of austerity measures, including a tripling of the value-added tax (VAT) and the suspension of cost-of-living allowances for public employees.
- The measures represent a decisive and proactive effort by Saudi leadership to stabilize state finances amid deepening fallout from the COVID-19 pandemic and the collapse in global oil prices.
- As the Kingdom tightens its belt, foreign investors should anticipate greater government focus on cost efficiency and local content and reduced spending power for Saudi consumers.
What do the cuts include?
The new austerity measures total SAR 100 billion ($26.6 billion), or roughly 10% of the original FY2020 budget, and include spending cuts and revenue increases:
- Cuts to capital expenditures: Saudi Arabia will cancel, extend, or postpone some operational and capital expenditures for government agencies. In his statement announcing the measures and a subsequent interview, Saudi Minister of Finance and Acting Minister of Economy and Planning Mohammed Al-Jadaan indicated that the government will also cut allocations for some of its major projects. Affected projects could include the Kingdom’s flagship Vision 2030 gigaprojects as well as other major projects such as the Jeddah metro. Total cuts to Vision 2030-related programs are rumored to total around SAR 30 billion ($8 billion). In recent months, a strategic committee has been working to review, reprioritize, and restructure the various Vision 2030 Realization Programs (VRPs), some of which could be downsized or cancelled.
- Subsidy cuts: The government will fully suspend the cost-of-living allowance for Saudi government employees starting in June, although Minister Al-Jadaan promised that welfare payments to low-income Saudis will continue. The allowance was introduced in 2018 in response to high inflation and was always intended to be temporary. The Kingdom will also cut fuel subsidies and benchmark domestic gas prices to international markets. Fuel prices have declined sharply, reflecting international oil prices.
- VAT increase: The government will increase the VAT from 5% to 15% starting in July. Minister Al-Jadaan noted that this is unlikely to raise significant additional revenue until next year, given that COVID-19 will continue to depress consumer spending. The Kingdom had planned to gradually increase the VAT since first introducing the tax in January 2018.
- Salary cuts: Finally, the Kingdom will form a special ministerial committee to review the salaries of all employees and contractors hired outside of the normal civil service system. In recent years, a divide has grown between the relatively modest salaries of civil servants and the much higher salaries paid by certain governmental and semi-governmental organizations in the name of attracting talent from the private sector. These include the organizations overseeing the VRPs and new authorities and centers that the government created in recent years as part of its restructuring. The committee has 30 days to complete its review and submit its recommendations.
Why are the cuts necessary?
As Minister Al-Jadaan noted, the COVID-19 pandemic has dealt three major financial shocks to the Kingdom, any one of which would necessitate government intervention:
- Collapse in global demand for oil: Since the COVID-19 pandemic began, global oil demand has cratered and prices have fallen by more than half. In response, Saudi Arabia—in coordination with the other OPEC+ countries—has cut its oil production by around 4.8 million barrels per day (bpd) from its April levels, which has thus far failed to shore up prices. The collapse in prices—coupled with production cuts—has significantly decreased Saudi government revenues, around 85% of which come from oil exports. Oil-related revenues fell by 24% in Q1, before oil markets had felt the full impact of COVID-19, and will likely contract significantly more in Q2.
- Shutdown of the domestic economy: The Saudi government instituted strict measures to control the spread of the virus relatively early on in the pandemic, including 24-hour lockdowns in major cities and a ban on travel between provinces. The Kingdom has also urged Muslims planning to take part in the Hajj pilgrimage to delay booking their trips, and suspended the lesser Umrah pilgrimage. Hajj and Umrah-related tourism accounts for up to 20% of Saudi non-oil GDP. After gradually loosening some restrictions and reopening shopping malls and some other businesses during the holy month of Ramadan, the Saudi government now appears to be backtracking amid an increase in cases. The Ministry of Health (MOH) has reportedly recommended imposing a full nation-wide lockdown during the Eid holidays (May 23-27). Coronavirus-related social distancing measures have brought the non-oil private sector to a near-halt and hit Saudi SMEs especially hard. Non-oil government revenues declined by 17% in Q1 and, as with oil revenues, are likely to contract significantly more in Q2.
- Increase in healthcare and other spending: The Saudi government has directed SAR 47 billion ($12.5 billion) to the MOH amid the pandemic, in addition to the SAR 120 billion ($32 billion) already allocated to the MOH under the FY2020 budget. The Kingdom has also spent an estimated SAR 130 billion ($35 billion) to support the Saudi economy. Although these spending increases may be partially offset by cost savings in other areas—including on state-funded tourism and entertainment events and on international travel by government employees—the Kingdom faces a budget deficit of at least SAR 262 billion ($70 billion) this year, according to Jadwa Investments, up from $35 billion last year. Saudi foreign reserves fell by $27 billion in March to their lowest levels in 20 years. With plans to increase borrowing on the international markets by up to SAR 120 billion ($32 billion) this year, the Saudi debt-to-GDP ratio is expected to rise from roughly 23% to 32%, according to new reports by Al-Rajhi Bank and Samba.
What do the cuts mean for business?
The austerity measures are emblematic of a new focus on fiscal discipline under Vision 2030. Although the measures may postpone certain Vision 2030 initiatives and force the government to choose which programs to prioritize, the pandemic is unlikely to spur a significant shift in government strategy around Vision 2030. On the contrary, the pandemic-driven collapse in oil prices has highlighted the problem of oil reliance and underscored the importance of the Vision 2030 push to diversify the economy.
In the short- and longer-term, the austerity measures have several implications for companies that do business in the Kingdom. Delayed payment or non-payment on government contracts—a problem often caused more by mismanagement than lack of funding—is unlikely to be as significant a challenge as it has been in the past. Since the pandemic began, the government has moved to pay all its outstanding dues to contractors.
However, the government will likely be more selective and cost-conscious in procurement decisions. Companies should also anticipate a heightened focus on local content as the government faces growing pressure to create jobs for Saudis. Meanwhile, the VAT increase and larger economic slowdown will cut into consumer purchasing power and may prompt Saudi consumers to become more conservative in their spending habits.
For companies that do business with the government and those that sell to Saudi consumers, the prestige associated with American companies may increasingly pale in comparison to cost-effectiveness. Chinese companies have gained ground in recent years both with the Saudi government and with Saudi consumers. Greater concern with cost-efficiency may further entrench their competitive advantage.
Albright Stonebridge Group (ASG) is the premier global strategy and commercial diplomacy firm. We help clients understand and successfully navigate the intersection of public, private, and social sectors in international markets. ASG’s worldwide team has served clients in more than 120 countries.
ASG's MENA Practice has extensive experience helping clients navigate markets across the Middle East and North Africa. For questions or to arrange a follow-up conversation please contact Michael Bessey.