Saudi Arabias VAT inflation impact to fade over year, say analysts

LONDON - While the introduction of value-added-tax (VAT) in Saudi Arabia on Jan. 1 has helped to push up inflation in the Kingdom, the impact of the new charge is expected to fade over the next 12 months, analysts said.

Consumer prices in the Kingdom rose by 3 percent in January year-on-year, according to official figures released on Feb. 25. This compares to a decline of 1.1 percent year-on-year in December.

Saudi Arabia brought in the 5 percent VAT charge as well as cuts to fuel and electricity subsidies last month in an effort to balance its budget and decrease its dependency on oil revenues.

Analysts said the impact of the VAT charge on inflation will be relatively short-term.

“We do not want to downplay the various impacts of the VAT, but we emphasize that on the inflation front the base effect linked to the VAT’s introduction will dissipate in 12 months from now,” Paul Wetterwald, chief economist for Indosuez Wealth Management said in a research note on Feb 26.

Wetterwald drew a comparison with Japan, where in April 2014 the country increased VAT from 5 to 8 percent which helped push up inflation to 3.7 percent year-on-year in May that year. The inflation rate retracted to 0.5 percent 12 months later.

Jason Tuvey, Middle East economist at Capital Economics, said that he expected inflation in Saudi Arabia to “hover around its current rate for the remainder of the year.”

He added that the hit to household budgets would be offset by an expected raft of bonuses for public sector workers.

Tuvey also noted that Saudi Arabia changed the base year used to calculate consumer prices from 2008 to 2013, which helped depress inflation figures, compared to if they had been calculated with the old data series.

The cost of food in the Kingdom was particularly affected by the VAT charge, with inflation in that sector rising from 0.5 percent in December to 6.8 percent year-on-year in January. All food items are subject to VAT.

Transport costs rose by 10.5 percent in January year-on-year following a number of price hikes, while inflation in housing and utilities reached 1.3 percent year-on-year.

The impact of VAT has also had an impact on the business climate within the non-oil sector, with Saudi Arabia’s purchasing managers’ index (PMI) declining to a measure of 53 in January compared to 57.3 recorded in December. Any measure above 50 indicates an expansion rather than contraction.