Saudi Arabia has decided to cut its cost of living allowance from June and to hike VAT from 5% to 15% from July 1.

As record low oil prices and the effects of the coronavirus crisis take their toll, Finance Minister Mohammed al-Jadaan said in a statement on Monday that the measures were necessary "to shore up state finances" amid a sharp decline in oil revenue, as the coronavirus scare reduces global demand for crude and cuts growth forecasts. The IMF projected the Saudi economy would fall 2.3% this year.

"So far, the minister of finance announced that the 'citizen account' that benefits lower income Saudis will not be affected," Yasmine Farouk, visiting scholar at the Carnegie Endowment for International Peace, said. "The increase in VAT will however affect the standard of living of all Saudis but those who will feel it the most would be the poorer of course."

"Both development and humanitarian aid will continue to be a central tool in Saudi foreign policy, especially in the absence of alternative tools that give Saudi Arabia as much of an influence and edge over other competing powers. Yemen is a place where Saudi humanitarian and development aid will definitely continue," Farouk added.

The kingdom first introduced VAT two years ago to help reduce reliance on world crude oil markets. The allowance of 1,000 riyals ($267, €240) a month to state employees, who make up two-thirds of total employment in the oil-rich kingdom, was also introduced in 2018 to offset increased financial burdens on poorer Saudis.

The government was also "canceling, extending or postponing" expenditure for some government agencies and cutting spending on projects introduced as part of the "Vision 2030" reform program aimed at diversifying the oil-reliant economy, the minister said.

Deficits bite

State media said the fiscal moves would raise state revenues by 100 billion riyals. The kingdom reported a $9 billion budget deficit in the first three months of the year as oil revenues in the period fell by almost a quarter from a year earlier to $34 billion, bringing down total revenues by 22%. The Saudi Jadwa Investment group predicts the budget deficit will hit a record $112 billion this year. Jadaan said the country would have to borrow $60 billion this year to plug the budget deficit.

Jadaan said he expected Riyadh could lose half of its oil income, which contributes about 70% of public revenues, as oil prices have fallen two-thirds since the start of the year. By comparison, Russia, the second-largest world exporter of oil, attributes 40% of its revenue to oil.

Backlash?

Riyads austerity policy is seen exacerbating public anger amid an already high cost of living and scrutiny of multibillion-dollar state projects. Also under the spotlight is a proposed 300 million pound ($372 million) Saudi-backed takeover of the Newcastle United football club in England. It is unclear if the NEOM project, a $500-billion megacity set to be built along the kingdom's western coast, will be impacted.

"Saudi citizens are starting to feel the economic impact of the virus in a concrete way," Middle East expert Yasmine Farouk from the Carnegie Endowment for International Peace, told the French news agency AFP. "With hardship will come more scrutiny of state spending elsewhere including the purchase of a football team and millions spent on entertainment events."

Transitioning to a more private sector-oriented economy could not have come at a worse time for the Saudi lower and middle class, according to Garbis Iradian, chief economist for the Middle East and North Africa at the Institute of International Finance (IIF), noting that Vision 2030 sought to decrease unemployment to 7% but that it will likely rise to 13% in 2020.

Although the government rarely releases statistics, it is estimated that around 20% of the 34 million Saudi population live in poverty. According to a 2017 UN report, the anti-poverty measures taken by the government were "inefficient, unsustainable, poorly coordinated and, above all, unsuccessful in providing comprehensive social protection to those most in need."

No turning back?

"The combination of record-low oil prices and mounting demographic pressures poses significant challenges to Prince Mohammed's (MBS) future plans in Saudi Arabia," according to The Soufan Center think tank.

"The high-tech city in NEOM is the crown jewel of MBS' future vision for Saudi Arabia, but it remains unclear how a prince's pet project will help the kingdom deal with its youth bulge. The government will have less cash to dispense as patronage to assuage Saudi citizens. The erosion of the social contract between the rulers and the ruled will lead to serious problems, especially in a tribal society.”

"The economic fundamentals have turned further against this fantastical project, but I don't expect MBS to give it up," said Kristin Diwan of the Arab Gulf States Institute in Washington. "It's the touchstone for everything he wants to achieve."

"If not handled carefully [the new developments] could really amplify already noticeable inequalities between wealthy young city dwellers and just about everyone else," said Diwan.

"But while many are discontented with the new direction in the country, Saudi Arabia doesn’t have an organized opposition movement inside of the country.  The Saudi leadership knows it needs to focus more on internal affairs, Diwan goes on. "They’ve already cut off Lebanon and are looking for a way out of the Yemen conflict.  Still, I don’t expect the Kingdom to withdraw completely from the contest for regional influence. The new nationalist leadership is always looking to exert Saudi interests and elevate its prestige," Diwan added.