Saudi Arabia’s economy has been hamstrung by the oil price crash and the ongoing Covid-19 pandemic. With limited visibility into the extent and duration of this unprecedented pandemic, the near-term outlook remains muted for Saudi Arabia.

Over the past few years, US shale oil production has consistently increased leading to higher oil supply in the market. Therefore, to keep Oil Prices down, OPEC and Russia had decided to curtail oil production. But, in March this year, Russia refused to cut down production. Saudi Arabia retaliated by announcing increases in oil production as well as offering purchasing discounts.

Exhibit 1: Global oil supply, demand, and gap, 1971 – 2019 (in million tonnes)

Source: IEA

Moreover, the unprecedented health crisis, that emerged this year, plunged the world economy into a severe contraction. With economic activities stalled, the global demand for crude sharply dropped amid a supply glut. Consequently, oil prices dropped to historic lows this year before recovering somewhat. Oil futures (WTI Futures expiring in May 2020) ventured into the negative territory for the first time. Brent crude is trading at $43.34 as of July 25, 2020, down 26% year-over-year.

Exhibit 2: ICE Europe Brent Crude Electronic Energy Future, Jul 2019 – Jul 2020

Source: Refinitiv Eikon

Saudi Arabia is the world’s largest exporter of crude oil and nearly 87% of its budget revenues come from the oil sector. Low oil prices do not bode well for Saudi Arabia’s economic well-being.

Saudi Arabia’s oil revenue for the first quarter of 2020 fell 24% year-over-year to USD 34 billion while the fiscal budget deficit for the first quarter stood at USD 9 billion.

With international borders closed, other sectors like retail and tourism will also be hit hard. Saudi Arabia saw some 16 million international travelers (mostly religious pilgrims) in 2018 and in that year, the tourism sector constituted 9% of the GDP.

Given the combination of the above-mentioned factors, the GDP for the country is expected to contract 6.8% for 2020, as per the International Monetary Fund (IMF). IMF has projected the global growth rate to shrink by 4.9% for 2020.

Will Saudis have to pay income tax?

The Saudi Arabia government is working towards shoring up its finances. Saudi Arabia, along with other OPEC+ members, has cut output by 9.7 million barrels per day (bpd) for May-July to support oil prices. Further, the country has increased the official selling prices (OSP) of crude to Asia by $1. The Saudi OSPs are important because these influence Iranian, Kuwaiti, and Iraqi oil prices and in turn, affect more than 12 million bpd crude bound for Asia.

Exhibit 3: Saudi Arabia oil production (bpd), 2002-2020

Source: Bloomberg, 2019 and 2020 are estimates

Under its Vision 2030 initiative, the state is looking to diversify its income by developing non-oil sectors like tourism and healthcare and revising taxation structure. The kingdom has tripled its value-added tax to 15% and suspended the cost of living allowance to its state workers. The government is considering the privatization of its assets across education, and health, sectors to raise money.

The state is reportedly looking to implement income tax in the country. Notably, Saudis are exempt from paying income taxes, given the sizeable oil revenue.

Income tax, if rolled out, could mean a seismic change for the Saudi regime. To make people pay taxes (who are not used to paying taxes) when economic activities are stalled could complicate the political situation in the Arab nation. Also, increased taxation could further deteriorate the already depressed consumer spending.

Moody’s says it is not all gloom and doom

Per Moody’s report, Saudi Arabia’s economy will grow at an average rate of 3% from 2021-2024. For 2020, the real GDP is expected to shrink by 4.5%.

Further, the report stated that the country’s strong credit profile (low debt and strong balance-sheet) and its vast hydrocarbon reserves, which are easy to extract compared to other countries are its biggest strengths. Nonetheless, the state’s effort to diversify revenues away from the oil sector is expected to be a time-consuming affair.

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