Economic and fiscal reforms in Saudi Arabia through to the end of 2019 have led to an impressive fall of the breakeven fiscal oil price. However, this was not enough to balance the Saudi budget.

According to the IMF’s estimates, a WTI oil price slightly above $80 per barrel would have been required to balance the 2019 budget. On average, the WTI barrel traded at $57 in 2019, while the Brent quoted $64 per barrel.

Given a 3.4% weighted average coupon for Saudi bonds, and a 2019 debt-to-nominal GDP ratio of 19% (similar to that of its regional peer, the United Arab Emirates), the cost of servicing the debt amounts approximately to $5’123 million (3.4% x 19% x $793’000 million) per year.

With such a cost, stabilizing the debt-to-GDP ratio would require a high nominal growth and/or a significant primary budget balance improvement (i.e. the public budget balance before payment of interests on debt). Neither of which are likely to happen in 2020, due to the current low oil price environment and the Covid-19 impact (more public spending and less growth).

Thus, the debt-to-GDP ratio is set to rise further. To what level, and for how long?

Over the years, Saudi Arabia’s government has been trying to reduce its dependency on oil revenue. Amongst the various measures to rebalance its budget, it introduced a 5% value-added tax (VAT) on 1 January 2018. The tax raised nearly SR45 billion ($12 billion) in its first year of collection. Now, as part of the government’s plan to save SR100billionamid the Covid19 crisis, Saudi Arabia will triple VAT to 15% from 1 July 2020. We will focus on the impact of the VAT rate increase on the debt-to-GDP ratio over a medium-term horizon, namely 2025.

Assuming a 5% nominal growth rate over 2022-2025, the debt-to-GDP ratio would be about15% lower due to the increase in the VAT rate. With different assumptions related to borrowing cost and/or nominal growth, the order of magnitude of the difference will remain the same.

With nominal growth and borrowing cost both at 5%, the ratio would comply with the original target retained at the set-up of the Euro zone. It can now only be labelled as a distant objective in Europa!

It was no surprise that the VAT introduction had a negative impact on the business climate in the non-oil sector, as can be seen in the sharp decrease in the purchasing managers index (PMI) to a low of 51.4 in April 2018. Nevertheless, at the time the PMI managed to stay above the 50 boom/bust line and rebounded during the following summer.

The environment is now quite different: the PMI registered an all-time low of 42.4 last March, before rebounding slightly. However, it stayed below the 50 frontier both in April (44.4) and May (48.1), meaning that the survey’s respondents saw business conditions deteriorating month after month. The tax increase will certainly contribute to depressed consumption from July onwards, it will also push up the consumer prices, as it happened in 2018. However, this base-effect will dissipate in July 2021.

Bottom line: While the so-called Misery Index (that is the addition of the unemployment rate and the inflation rate) will undoubtedly shoot up in Saudi Arabia in 2020, the health of its public finance will still compare favourably with most of other countries on a longer term.

About the author: Dr Paul Wetterwald is Chief Economist for Indosuez Wealth Management