The global Covid-19 pandemic is causing economic problems for countries throughout the world in 2020. In response to challenging economic and fiscal circumstances, some countries have introduced very different changes to VAT rates.
As in most other countries, the government of Saudi Arabia has imposed closures and restrictions on businesses to prevent the spread of the virus. However, the main economic impact on Saudi Arabia from the pandemic has been caused by declining oil revenues. The petroleum sector contributes most of the country’s budget revenues – as of June 2020, world oil prices have fallen by over 30% compared with June 2019, pushing the kingdom into a budget deficit.
In response, the rate of VAT – first introduced in 2018 – has increased from 5% to 15% as of Wednesday 1 July 2020. The change is part of a package of austerity measures to be introduced, including suspending the cost of living allowance of SAR 1 000 per month paid to state employees. Capital expenditures will be reduced and planned economic reforms will be postponed.
Saudi Arabia’s VAT has few exemptions or zero-rated items. Therefore, the change will affect the majority of items in ECA’s cost of living basket. However, not all goods and services will immediately rise in price by 10%. Retailers may initially limit price changes and absorb some of the increase to maintain market share. Retailers may also already have begun to increase some prices in anticipation of the VAT increase.
When VAT of 5% was introduced in 2018, ECA measured price rises of around 5% over the six-month period after the tax was introduced. However, this does not tell the whole story as at the same time petrol prices more than doubled during the same period. Excluding motoring, inflation was almost 2% lower. Also, in the previous six months inflation had been 1.6% so the change in the rate of inflation was significantly less than the change in VAT, especially if we excluded the extreme change in petrol prices.
As part of the package of reforms, petrol prices in Saudi Arabia have fallen by almost 50% compared with ECA’s March 2020 cost of living survey. This will significantly offset the impact of the VAT increase.
Should retailers pass the full VAT rise onto consumers, the average estimated impact would be an 8% increase to prices compared to the March 2020 survey taking into account the decrease in petrol prices. However, for the aforementioned reasons, it is expected that some retailers will hold back from passing on the full price rises, at least initially. It should also be noted that the impact to indices will vary by the home country and will factor in exchange rate movements since the March 2020 survey.
We are currently conducting a survey of prices in Saudi Arabia to assess the impact of the VAT change. Should your organisation require further advice on managing assignees affected by the recent changes, please do get in touch.
In contrast, Germany’s VAT rates are to be temporarily cut as part of a EUR 130 billion programme of fiscal support to provide economic stimulus in response to the pandemic. The standard rate of VAT will be reduced from 19% to 16%, while the reduced rate (applicable to essential supplies including food, medicine and books) will be reduced from 7% to 5%. The temporary rates will take effect from Wednesday 1 July 2020 and will remain in place until 31 December. Again, most items in ECA’s cost of living basket will be affected by the change – however, it is not clear yet what the overall impact to indices will be, especially as it is expected that petrol prices will fall between March and September.
ECA will update cost of living indices for Germany in our September 2020 survey and while this will inevitably take into account the temporary VAT change, it may only have a limited impact across the basket as a whole for the reasons above. For example, we expect lower petrol prices to have a large impact too, and the recession triggered by the global pandemic will also affect prices in a variety of ways.
Cost of living is always based on a snapshot in time, but we are aware of the temporary nature of this tax cut and we will consider this during our analysis once we have the data and can see how prices have changed.
Other VAT news
While Germany is the first major economy to have announced a temporary VAT cut, many other countries are reportedly considering a similar measure to stimulate retail spending as their economies emerge from lockdown, including the United Kingdom, Mexico and Italy.
It is expected that there will be changes to VAT rates in several countries in 2020. However, it is important to note that not all items will be affected in the same way and other factors including exchange rates may have a more significant impact on the cost of living index than changes to VAT. The impact of all changes to VAT or sales tax rates in the coming months will be measured in ECA’s September 2020 cost of living survey but in the meantime, please contact ECA if you have any questions.