Inflation to ease in Saudi Arabia in 2019 as VAT impact wears off

Inflation in the kingdom is forecast to fall to 2.2 per cent in 2019, from an average 2.6 per cent this year

The Riyadh skyline. Inflation in Saudi Arabia is set to moderate in 2019, Fitch Solutions says. Reuters

Inflation in Saudi Arabia will ease next year, as the effects of fuel subsidy cuts and VAT implementation in Middle East's biggest economy wears off.

Inflation in the kingdom is forecast to average 2.6 per cent in 2018, falling to 2.2 per cent in 2019, up from deflation of 0.9 per cent recorded in 2017, Fitch Solutions, a unit of Fitch Ratings, said in a report released on Monday.

“In 2019, we expect a more pronounced deceleration in price growth as the base effects of subsidy cuts and VAT fall off,” Fitch said. “This view is also underpinned by our expectation for the Saudi government to shift away from fiscal consolidation next year, which means that any further subsidy cuts or tax hikes are unlikely to prove substantial or to have a major impact on inflation.”

Saudi Arabia, Opec’s biggest oil exporter, along with its GCC peers, had to tighten purse strings in the wake of a three-year oil price slum that saw the crude benchmark fall from its mid-2014 peak of $115 (Dh422) per barrel to less than $30 per barrel in the first quarter of 2016. Riyadh restructured fuel and utilities subsidies and borrowed aggressively from local and domestic markets to plug the budget deficit. Saudi Arabia and the UAE were among the first Arabian Gulf states to implement VAT at the beginning of this year to generate alternative revenue streams.

Subsidy reforms and VAT at 5 per cent will continue to put upward pressure on prices in the near-term, particularly in the transport and food and beverages segments. Both sectors have seen price increases at an average of 10.4 per cent and 6.2 per cent year-on-year, respectively, in the first nine months of this year, Fitch said.

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However, persistent weakness in the housing market will mitigate the pressure to a large extent, the report said.

On the monetary policy front, the Saudi Arabian Monetary Authority (Sama), is expected to continue supporting confidence in the riyal’s dollar peg, hiking its benchmark rate in line with the US Federal Reserve. Since the beginning of 2018, Sama has raised its main policy rate by a cumulative 75 basis points.

“We forecast one more 25bps hike this year and four more in 2019 - taking the rate to 3.25 per cent - as Sama looks to avoid pressure on the riyal’s dollar peg by closely tracking the US Fed. Given the gradual pace of monetary tightening and the improving dynamics of the all-important oil sector, we do not expect these hikes to have a substantial impact on the kingdom’s headline economic growth,” Fitch said.

Separately, the kingdom’s Ministry of Finance on Sunday evening announced it closed a deal to raise 3.25 billion riyals through the sale of Islamic bonds.

The transaction under the Saudi Arabian Government riyal-denominated Sukuk programme is split into three tranches of 2.33bn riyals maturing in 2023, a 360 million riyal tranche maturing in 2025, and the third tranche of 560m maturing in 2028, according to a ministry statement carried by Saudi Press Agency.