The fiscal cuts announced by Saudi Arabia on 11 May equate to c4% of GDP and a prior fiscal deficit of 12.6% (2020 forecast from IMF). The measures include a VAT hike (from 5% to 15%), ending a cost of living allowance for public sector workers and project spending delays. The VAT increase is, in our view, unlikely to be reversed and could equate to 4% of GDP in annual recurring fiscal revenue.
We draw the following domestic, regional and global implications.
(1) Saudi consumer – This is another blow to consumer spending growth that has already decelerated very sharply (following the oil price fall and Covid-19 disruption to retail and tourism): the hike in VAT and the removal of public sector cost of living supplemental allowance compounds the effect of job losses, and the removal of private sector salary and hours cuts (of up to 40%), and likely job losses (particularly in the expatriate labour force).
(2) Saudi income tax – The existing VAT framework (reporting requirements, auditing procedures) allowed for rapid implementation of an increase in the tax rate. Longer-term, this is another indicator that wider corporate and personal income taxes are an inevitable part of the non-oil fiscal armoury.
(3) Saudi political risk – The centralisation of power under Crown Prince Muhammad bin Salman has demonstrably dealt with dissent in the wealthier segment of society and projected a mix of nationalism, security, social reform, the liberalisation of entertainment, and targeted welfare to preserve social stability among the less affluent mass population. Of course, domestic political threats remain ever present and a much weaker economic climate increases vulnerability. But we reiterate our view that as long as the Crown Prince retains monopolistic control over the military and security apparatus and the US remains a key supporter, then the risk of social discontent turning into something which puts the succession or the regime at risk remains a very low probability.
(4) Saudi equities – The local Tadawul index is down 20% year to date, broadly in line with MSCI EM (down 18%). Banks, Cement, Chemicals, and Consumer Non-Food have, in general, under-performed Aramco, Consumer Food, Healthcare and Telecom. Trailing price/book of the index is 1.6x, merely a 7% discount to the 5-year median. We are not that enthusiastic about Saudi equities relative to alternatives in the Middle East (Egypt), oil exporters (Kazakhstan), large and liquid EM (Technology). Within the narrow peer group of the GCC, Qatar is better able to withstand the current crisis environment (with greater firepower for fiscal stimulus) but when conditions normalise (in terms of Covid-19) we see more low-hanging fruit for non-oil diversification in Saudi.
(5) Saudi US$ sovereign debt – The 2028 3.625% Saudi US$ sovereign bond, rated A1 by Moody’s and A by Fitch, currently has a mid-yield to maturity of 2.8%, broadly in line with the start of the year but down from a mid-March peak of 4.3%. The current z-spread of 229bp is over 300bp narrower than EMBI (compared to about 180bp narrower at the start of the year). Clearly, actions which rein in fiscal deficits should be positive for fixed income investors.
(6) GCC disunity and competition – A common framework for 5% VAT across the GCC was agreed in June 2016. But implementation has been very uneven with Saudi and the UAE moving ahead first in January 2018, Bahrain in January 2019, and with Kuwait, Oman and Qatar yet to implement. A differential of 15% at one end (Saudi) and zero at the other (eg Qatar) creates a substantial competitive disadvantage when it comes to cost and attractiveness of doing business. This is another example of a lack of coordination in the GCC: a strain most evident in the Qatar blockade and one that is likely to worsen for this regional bloc – as it is for others like the EU – through the Covid-19 and oil crises.
(7) Oil price – This partly addresses one of the weaknesses of Saudi in fighting with Russia over the power to set the marginal price of oil: Russia entered the oil price war with much lower fiscal break-even oil price (approximately US$40 versus US$85 for Saudi). This could be interpreted as Saudi preparing itself for lower oil prices for much longer.
(8) Remittances in oil importers (and labour exporters) – GCC remittances (of which Saudi accounts for over half) equate to a substantial portion of GDP (approximately 2% to 8%) for the likes of India, Bangladesh, Philippines, Lebanon, Sri Lanka, Pakistan, Jordan and Egypt. Pressure on overall economic growth and consumer growth in particular usually negatively impacts the expatriate community disproportionately (because they do not represent as politically important a constituency as the citizen base).
Below we present charts on Saudi consumer and corporate confidence metrics, GCC fiscal forecasts (prior to the April OPEC+ deal and most of the crisis stimulus or austerity actions), global oil exporter fiscal break-even oil prices and tax revenues, and recent performance of Saudi equities and sovereign US$ debt.
GCC: The Gulf is not a safe haven unless (at least) oil prices recover, 1 April 2020
Oil spat turns into a splat: A reminder of the winners and losers in EM, 21 April 2020
Kuwait, GCC: The expat debate stirs again, 15 April 2020
GCC: Sovereign wealth warning from the IMF (again), 7 February 2020
If remittances drop 20% who is exposed in emerging and frontier markets?, 29 April 2020