Economic Research GCC Economic Outlook 14 June 217 GCC: Assessing the economic impact of VAT VAT: A critical step in deepening fiscal reforms GCC countries are due to start introducing a value-added tax (VAT) of 5% on goods and services from January 218 in a broadly coordinated manner. The implementation of this indirect taxation is a vital stage in deepening the GCC states fiscal reform programmes, which have largely focused on lowering government subsidies, raising government fees and retrenching spending so far. GCC countries have weak tax bases and the introduction of VAT is a key initial step in diversifying and raising government revenues. Oil revenues still account for between 5-85% of total government income in the GCC despite the lower oil price since 214. We see the relatively low rate of VAT being introduced in the GCC reflecting a move to start widening the tax base rather than to balance the fiscal budgets. We see the potential for the standard VAT rate to be raised going forward, but only in the medium term. Economics Team Monica Malik, Ph.D. Chief Economist +971 ()2 696 8458 Monica.Malik@ Shailesh Jha Economist +971 ()2 696 274 Shailesh.Jha@ Contents I. Background: Introduction of VAT in GCC 2 II. Economic impact of VAT 5 GCC: Government revenue to be boosted by 1.2-1.6% of GDP The impact of VAT on inflation and government revenue will vary depending on the proportion of consumption in the economy and how much of the consumption base is captured by VAT. GCC countries have not yet published their individual VAT laws there is scope for some differences in VAT classifications thus our estimates so far are based on individual administrations indications. We forecast that GCC countries will raise between 1.2-1.6% of GDP in the first year after the introduction of VAT, with the and Saudi Arabia likely to see the greatest revenue generation (c.1.5-1.6% of GDP). In the case of the, we believe that the relatively higher revenue potentially raised from VAT reflects the larger share of private consumption in the economy. Nevertheless, the possible VAT classifications indicated by the official briefing sessions suggest that the is looking to support key sectors of the economy. Meanwhile, indications from Saudi Arabia suggest that it could have the broadest VAT base amongst the GCC, aimed at maximising revenue from the new tax. Overall, we see revenue rising moderately in the second year post-introduction. GCC: Inflation to spike, further weakening consumption One of the main economic impacts of the introduction of VAT will be a spike in consumer price inflation in the first year of the new tax s introduction. We estimate that VAT could add c.2.7-3.7pp to headline inflation in the first year. However, the introduction of the tax in other countries shows that it can take a few months for the potential rise in prices to fully filter into the inflation data. Again, we see potential for Saudi Arabia seeing the greatest percentagepoint (pp) rise in inflation related to VAT as it is likely to have the widest tax base. However, we expect that businesses will not be able to pass on all VAT charges to consumers given the weak demand environment, thus impacting corporate margins and resulting in further measures to reduce costs. We believe that individual states ability to adjust to the introduction of VAT will depend on the underlying economic environment. We see a further acceleration in real non-oil GDP growth in the in 218 as investment momentum builds in Dubai. Meanwhile, we see a softening in non-oil GDP growth in Saudi Arabia in 218. 1
GCC Economic Outlook 14 June 217 I. Background: Introduction of VAT in GCC A. What is VAT and when will it be implemented? Value added tax (VAT) is a broad-based indirect tax levied on the consumption of goods and services. The GCC countries are looking to introduce VAT from 218 in a coordinated manner at a standard rate of 5%. All GCC countries have signed a Unified VAT Agreement, which outlines a common framework. This framework is vital to avoid competitive distortions between the GCC countries. However, there will be some variation in the national VAT laws of individual GCC countries when the new tax is introduced next year, which is allowed under the framework. A number of GCC countries have indicated that they are targeting introducing VAT on 1 January 218, including Bahrain,, Saudi Arabia and the. We believe that the and Saudi Arabia will likely be the first to introduce VAT in January 218, with Qatar also potentially introducing VAT early on. The other GCC countries will have 12 months to introduce the tax once the first two have done so. Separately, the GCC countries are also looking to introduce an excise tax on harmful products (tobacco and sugary drinks) aimed at raising revenue, though these funds will also be spent on social benefits. All GCC countries have signed a Unified VAT Agreement B. VAT collected at various production stages VAT is an indirect tax as it is not collected by the government (such as income tax). Rather it is collected by businesses at every stage of the supply chain on behalf of the government. Meanwhile, businesses can reclaim refunds from the government for VAT paid to suppliers. Thus, VAT will ultimately be borne by the final consumers rather than being a tax on business activity. VAT collected by companies for government Fig. 1. AED Stage 1 Stage 2 Stage 3 Example of VAT being collected through supply chain but ultimately paid by consumer Production stage Sales value VAT recovered on inputs 5% VAT charged on sales Net VAT collected by the government Farmer - produces and sells cotton to a factory 1 5 5 Factory - manufactures and sells clothes to a retailer 3 5 15 1 Retailer - clothes stocked and sold to consumers 5 15 25 1 Total VAT paid by consumer 25 Source: Ministry of Finance, ADCB estimates In an effort to target final domestic consumption of goods and services, the general VAT framework stipulates that: i) business are allowed to reclaim the VAT paid on input tax (except in the exempt category); ii) VAT tax is applied to imports; and iii) exports outside the GCC are zero-rated. Official indications suggest that VAT on imports will be collected in different ways across the GCC. The is looking to collect VAT on imports on a reverse-charge basis, i.e. VAT will not have to be paid at the point of import. However, Saudi Arabia and will likely collect VAT at the first point of entry into the country. Thus, for the latter countries, there is the potential for a greater impact on cash but ultimately paid by consumers 2
GCC Economic Outlook 14 June 217 flow for businesses that rely heavily on imported inputs (i.e. as VAT must be paid up front). C. Three categories for VAT classification Under the common GCC frameworks, VAT-applicable goods and services will be divided into three categories: VAT rate will be 5% for areas covered Zero rate % VAT charged, VAT credit available. Sales will still need to be recorded in companies VAT returns, as with other categories. Standard rate of VAT 5%. Most goods and services will likely fall in this category, including electronics, cars, dining out and entertainment. The 5% VAT rate will be passed on to consumers, with VAT credit available for corporations. Exempt VAT on inputs is not passed on to consumers, thus no VAT credit is available. Corporates will not be able to recover or reclaim the 5% VAT incurred on exempt items or services. Thus, exempt inputs have the potential to erode business profit margins unless corporates can pass them on. We believe that this category reflects the fact that in such instances, corporates are the final consumers of those goods or services. Fig. 2. GCC: Tax classification under GCC s Unified Agreement for VAT* Subject to Standard Rate of 5% Food products to be subject to the basic rate of VAT, though each country will have the right to levy a zero-rate on foods classified under the unified list of commodities (see the May be Zero-rated category). Must be Zero-rated Medicines and medical equipment Cross-border transportation services of goods and passengers Goods exported outside the GCC May be Zero-rated Oil, oil derivatives and gas sectors Certain food items - basic foods such as bread, milk, etc. Around 1 food items listed to potentially be zero-rated Can be Zero-rated, Exempt or Taxable Exempt Education sector Healthcare sector Real estate sector Local transport sector Member states have the right to exempt the financial services of banks and other financial institutions. Such exemptions are not expected to be extended to fee-based services. * Text of the agreement was published by the Saudi Official Gazette on 2 April 217. Source: Ernst & Young, Deloitte, PWC, ADCB estimates The classifications of goods and services into the different categories will be critical for the economic impact of the introduction of VAT, including the resultant rise in inflation and government revenue generated. Each GCC country will have some discretion to determine different VAT treatments regarding categories within the GCC framework (Fig. 2). However, certain categories must be either zero-rated or exempt based on the GCC Unified Agreement. The VAT classifications of goods and services by individual GCC countries have yet to be announced, though there have been some indications (see below for the ). At the time of publishing, only Qatar s cabinet has passed its VAT law. Differences in classifications by country 3
GCC Economic Outlook 14 June 217 Fig. 3. GCC: Registration thresholds for VAT Annual turnover Required to register Voluntary registration GCC Above USD1K Above USD5K, but below USD1K Source: Ernst & Young, PWC D. : Indications of classifications The s Ministry of Finance (MoF) has been holding a number of workshops and briefing sessions aimed at disseminating details on VAT. In these workshops, the MoF has suggested the below classifications. However, these are subject to change, and the classifications below will be confirmed when the VAT law is released. Zero-rated: Healthcare and education will be zero-rated in the rather than exempt. The first sale of residential properties (i.e. from the developer to the first purchaser) will be zero-rated, which will provide support to the real estate and construction sectors. Cross-border transport will also be zero-rated, which will be positive for airlines. Standard 5% VAT: The MoF has indicated that all food items will fall under the 5% VAT rate, including basic goods. This is to avoid difficulties in administration. Imported goods and services will also be taxed at 5%. Meanwhile, commercial property (sales and leases) will be subject to the standard rate of VAT. Domestic goods transportation will be subject to the standard rate of taxation unlike international transport. VAT will also be applicable to utility bills (electricity and water) as well as mobile telephone and internet bills. MoF has indicated possible VAT classifications Education and health expected to be zero-rated as well as residential rentals Food items, imports and commercial properties will be subject to 5% VAT Exempt: The indications so far suggest that margin-based financial services will be exempt, though fee-based products will be subject to the standard rate. Local passenger transportation (such as taxis and buses) will also be exempt. Residential property (sales and leases) will be exempt from VAT, with the exception of the first sale (zero-rates). Other areas that are expected to be on the exempt list include government fees, cleaning and security. In the, a federal tax authority has been created to manage VAT and an excise duty on harmful products (expected to be introduced in 4Q217). There are no official indications yet as to how the VAT earnings will be divided between the federal and Emirate levels. Businesses will be required to report sales and purchases at an Emirate level on their VAT returns. Recent indications suggest that it has not yet been decided whether tourists will have to pay VAT, i.e. if the tax will be refundable when leaving the country. In earlier communications, the MoF indicated that tourists will also have to pay VAT, with the tax not refundable when leaving the country. The MoF noted that the VAT rate was kept deliberately low to limit the burden on consumers. Meanwhile, we await clarification on whether VAT will be implemented in the free trade zones. No indication on how VAT will be divided between federal and Emirate levels 4
Italy Argentina UK France Germany India Turkey Russia Brazil Mexico South Africa China Australia Indonesia Japan Switzerland South Korea Canada Singapore Malaysia GCC* GCC Economic Outlook 14 June 217 II. Economic impact of VAT We see the introduction of VAT as a highly positive development for the GCC as it will be a vital step in deepening and diversifying government revenues and reducing the region s reliance on oil income. This is especially important as the medium-term oil-price outlook remains weak. Moreover, the negative impacts associated with the introduction of VAT are expected to be short-term, i.e. one-off effects. These include rising consumer inflation, weakening consumption, and administrative adjustments for corporates to collect and manage VAT. We believe that the 5% standard VAT rate has been set to balance raising government revenue with limiting downside pressure on economic activity (by dampening domestic demand). The 5% rate is low on a global basis (Fig. 4). The global average VAT rate is c.15%, with most countries having seen a rise in their VAT rates over time. Moreover, some key areas of essential public spending will not see a VAT-associated rise in prices as they will be designated either zero-rated or exempt. Nevertheless, we expect a contraction in consumption activity in the GCC in the first year that VAT is introduced. We also expect a cumulative adverse impact on domestic demand and private consumption from VAT after two to three years of fiscal consolidation in the region. For our economic forecast, we currently assume that only the and Saudi Arabia will introduce VAT in early 218. VAT highly positive for diversifying government revenue Low rate of VAT - looking to balance revenue generation with limiting downside pressure on demand Fig. 4. GCC: Introductory VAT rate for GCC will be low from a global perspective %, VAT and GST rates 25 2 15 1 5 *to start being introduced from 1 January 218 Source: Ernst & Young, Deloitte, PWC We expect to see the 5% standard VAT rate rise going forward although not in the short term. A. Boost to government revenues The IMF has noted that VAT is highly effective at mobilising tax revenue. It is vital for the GCC countries to increase their non-oil and tax revenue, with hydrocarbons still dominating income for most governments in the region. The GCC states depend on hydrocarbon revenues more than other high commodity-exporting economies (Fig. 5), with hydrocarbon revenues still accounting for between 5-85% of total revenues (Fig. 6). This share has fallen from the pre-214 levels, though largely due to the lower energy price and to a lesser degree to fiscal reforms (cuts to subsidies and introduction of fees). The introduction of VAT is in line with the wider fiscal reforms introduced since 215, and in some cases, the increase in government revenue could be significant. Introduction of VAT a vital first step in deepening tax revenue base 5
GCC Algeria Angola Mexico Kazakhstan Saudi Qatar Nigeria GCC Economic Outlook 14 June 217 Fig. 5. Global: GCC countries more reliant on hydrocarbon revenues than other commodity producers %, of non-oil GDP 6 5 4 3 2 1 Oil Revenue Non-oil Tax Revenue Non-oil Non-tax Revenue Fig. 6. GCC: Hydrocarbon earnings still dominate government revenue sources %, hydrocarbons as a % of total government revenue 1 8 6 4 2 212-14 215-17 Source: IMF Source: Regional central banks, IMF, ADCB estimates The expected rise in government income generated from the introduction of VAT will depend on a number of factors. These include the parameters of the VAT system such as the classifications and thresholds. This will define how much domestic private consumption is captured. Secondly, the size/contribution of private consumption in the economy will be a critical factor. Finally, other factors such as the administrative efficiency of collection will also be influential. We estimate that VAT in the GCC could raise government revenues by between 1.2-1.6% of GDP in the first year of its introduction. Within the GCC, we expect the and Saudi Arabia to see the largest revenue generation from VAT. In the case of the, we believe that the relatively higher revenue (in % of GDP terms) reflects the larger share of private consumption in the economy. Moreover, initial indications suggest that all food products will fall under the standard VAT rate of 5% in the. This might not be the case for other GCC countries where 1 or so basic food stuffs may be zero-rated. We estimate that the could raise revenue of c.1.6% of GDP from VAT in the first year following its introduction. In the case of the, we estimate that the introduction of VAT in 218 could help to bring the fiscal deficit down to a more balanced level. We currently estimate a fiscal deficit of just around -.2% of GDP in 218 for the. This is despite expectations of a pick-up in government expenditure, especially in Dubai as we approach Expo 22. We also see the potential for Saudi Arabia earning c.1.5% of GDP from VAT as it is likely to have the broadest VAT base. There are some indications that Saudi Arabia might apply the standard 5% VAT rate to a number of sectors that were previously assumed to be zero-rated. These could include all food stuffs and local transportation, alongside private education and healthcare. There is also the possibility that residential rents could see VAT at standard rates. As a result, Saudi Arabia could have the widest VAT base in the region. Meanwhile, in the case of Qatar, we believe that the consumption base is likely larger than implied from the data (Fig. 7). Consequently, we currently assume VAT revenue generation of around 1.2% of GDP, versus c..8% of GDP implied from the data, which shows a relatively limited consumption in the economy. Potential revenue generation by GCC countries will vary on a number of factors VAT revenue generation will vary from 1.2-1.6% of GDP in first year of implementation and Saudi Arabia likely to see greatest revenue generation as % of GDP 6
Saudi Qatar* Saudi Qatar GCC Economic Outlook 14 June 217 Fig. 7. GCC: has largest share of private consumption out of total economic activity USD billion (LHA); % of GDP *RHA) 3 25 2 15 1 5 Private Consumption, USD billion (LHA) % of GDP (RHA) 7 6 5 4 3 2 1 Fig. 8. % of GDP 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1..9.8 GCC: Estimated government revenue from first year of VAT post-introduction * We estimate that actual consumption is higher in Qatar than implied in the data. Source: Regional central banks and statistical agencies, ADCB estimates Source: ADCB estimates We expect to see revenue from VAT increasing (even with a steady VAT rate) in the second year onwards as the administrative efficiencies of VAT collection improve. Surveys by a number of media outlets suggest that many corporates are unprepared for the implementation of VAT despite the approaching deadline. For the, we expect VAT revenue to increase to 1.8% of GDP in the second year of collection (assuming no changes to VAT guidelines). Moreover, we see some pick-up in consumption spending from the second year onwards. Our estimates are currently based on a number of assumptions as the VAT laws have not yet been published. We assume that most GCC countries (ex- and Saudi Arabia) will zero-rate basic foods. Moreover, we estimate that residential housing will either be zero-rated or exempt across the region, with the possible exception of Saudi Arabia. For the, we assume that VAT refunds will not be available for tourist spending. However, indications from other countries suggest that the impact on revenue would likely be limited if this was not the case, given the low levels of reclaims versus total spending by tourists. As data is not available to break down private consumption spending, we use the weighting of GCC inflation baskets, which should reflect the composition of household expenditure. Moreover, GCC countries are also looking to introduce an excise tax on harmful products. Saudi Arabia (implemented 11 June 217) and the (4Q217) have announced implementation dates in 217. Both countries are looking to levy a 1% tax on tobacco products and energy drinks. Carbonated drinks (ex-sparkling water) will be taxed at 5%. Given the small component of these products in the inflation baskets and likely in consumption activity, we believe that the impact on inflation and government revenues will be limited, with the benefits to be mainly seen on the social fronts. We therefore do not expect GCC countries to earn more than c..2-.3% of GDP per annum from the introduction of this excise tax. Separately, Saudi Arabia will also start raising fees on the dependants of expatriate workers from 1 July 217, at SAR1 per month. The government assumes that it will raise c. SAR1 billion from the fee in 217. Saudi Arabia s medium-term fiscal objectives also outline plans to liberalise fuel and consumer electricity prices to an undisclosed international reference rate, possibly in July 217. However, the revenue generated will be moderated by the means-tested Household Allowance Program, which will provide support to low-and mid-income families. Assumptions behind our VATrelated revenue forecast Excise tax to generate c..2-.3% of GDP per annum Saudi Arabia looking to progress with fiscal reform in 2H217, though no announcements yet 7
Saudi Qatar Saudi* Qatar GCC Economic Outlook 14 June 217 B. Spike in inflation with VAT introduction One of the main economic impacts of the introduction of VAT will be a spike in consumer price inflation in the first year of the new tax s introduction. However, the fact that some key components of the CPI basket will be either zero-rated or exempt will mean that the percentage point (pp) rise in inflation directly from VAT will be less than the 5% standard rate, especially as residential housing tends to have the largest weighting in the inflation basket. However, while food also has a high weighting, only around 1 basic products have the option of being zero-rated. As noted earlier, the is expected to tax all food products at the standard 5% rate, with Saudi Arabia also likely to do the same. We estimate that VAT could add c.2.7-3.7pp to headline inflation in the first year postintroduction. However, the introduction of the tax in other countries shows that it can take a few months for the potential rise in prices to fully filter into the inflation data. This is as: i) price scrutiny increases just after the introduction of VAT; ii) there is competitive pressure to limit price rises; and iii) consumer spending tends to slump once the new tax is imposed. Nevertheless, we see the greatest potential for a percentage-point (pp) rise in inflation in Saudi Arabia, which could have the broadest VAT base. We estimate that Saudi Arabia could see a c. 3.7pp rise in inflation from the introduction of VAT. In the, we see VAT adding c.3pp to the headline figure. However, we note that the (and to a lesser degree Qatar) should see weaker underlying inflation in 218 (i.e. ex-vat impact) with limited energy-related inflation. Higher fuel prices have been the main driver of inflation in early 217, though will see a sharp moderation in 2H217, especially in 4Q. Moreover, we expect to see limited pressures on house prices and expect further declines in rental prices in both Abu Dhabi and Dubai in 218 with new supply outpacing demand. VAT to be main driver of higher inflation in 218 VAT to add 2.7-3.8pp to headline inflation in first year postintroduction Fig. 9. GCC: Expected percentage-point rise in headline inflation post-introduction of VAT Pp rise in headline annual inflation 4. 3.5 3. 2.5 2. 1.5 Fig. 1. GCC: Expected spike in headline inflation, assuming all GCC countries introduce VAT on 1 January 218 %, annual average 6 5 4 3 2 1 217 218 219 Source: ADCB estimates * For Saudi Arabia we have not assumed any further subsidy reforms in 2H217 at this point, though this is a fiscal objective of the government Source: ADCB estimates Overall for the GCC region, we expect soft demand and regional USD currency pegs to keep underlying inflation low in 218. Thus, VAT is largely expected to be the main driver of inflation in 218 when it is introduced. If VAT is introduced across the GCC in January 218, we would expect to see realising the highest inflation rate, as things currently stand. This is as its higher utility rates from May 217 will continue to affect the y-o-y inflation data for 4M218. Moreover, has been seeing the greatest housingrelated inflation in the region, despite the recent moderation, with the country s investment programme steadily building momentum. However, we see the greatest potential for delays to the roll-out of VAT in out of all the GCC countries due to GCC underlying inflation (ex-vat) to remain weak; generally has higher underlying inflation 8
Qatar Saudi 21 211 212 213 214 215 216 GCC Economic Outlook 14 June 217 the current parliamentary opposition to fiscal reform. Thus, the higher y-o-y utility inflation may have fallen out of the inflation data before VAT is introduced. Saudi Arabia had earlier indicated that it will reduce subsidies further from mid-217 (fuels and electricity), once the Household Allowance Programme is in place. There have been no announcements so far of these outlined reforms, and thus we have not included potential subsidy cuts in our 217 and 218 inflation forecasts for Saudi Arabia. However, if there is any liberalisation of prices in 2H217, we would expect Saudi Arabia to see the highest inflation rate in 218. Fig. 11. GGG: Housing and food have the greatest weighting in GCC inflation baskets %, weighting in CPI baskets 4 Housing & Utilities* Food Fig. 12. : Private consumption in 216 (in real terms) remains c.3% lower than 214 level USD billion (LHA); % change y-o-y (RHA) 25 Private Consumption, USD billion (LHA) % change y-o-y (RHA) 15 3 2 1 2 15 1 5 1 5-5 -1-15 * This component includes utilities, which will likely be subject to the standard 5% VAT rate. We factor this into our inflation estimates. Source: Regional Central Banks and Statistical Authorities Source: Federal Competitiveness and Statistics Authority Our inflation forecasts linked to VAT assume that corporates will not be able to pass on all VAT charges to consumers given the weak demand environment. Nevertheless, the soft pricing environment could pose additional downside risks to our inflation forecasts. We believe that in some sectors, companies will have to absorb some of the VAT to remain competitive rather than passing it on to the end-consumers. Corporates will have to find a balance between maintaining their margins and reducing customer demand. Notably, price discounting has been a key feature across the GCC over the last few years to support demand at a time of fiscal reforms and retrenchment in government spending. This includes price discounting to support external demand (tourism, retail, hospitality) in economies such as the where the strong USD has also hampered competitiveness. We expect this trend to continue in 218, including in average daily room rates (ADRs) for hotels as greater supply enters the market. We also assume that wider fiscal reform will be limited in 218, which could further increase inflationary pressure. The spike in inflation is expected to be a one-off in the first year of the introduction of VAT, with inflation falling sharply thereafter. We do not expect to see any meaningful build-up in secondary inflation due to i) a limited rise in wages linked to the introduction of VAT; and ii) merchants being unable to raise prices by more than the 5% linked to VAT. Again, with the softer demand backdrop, the region will likely see the ongoing move to improve productive efficiencies and reduce costs, resulting in an ongoing soft labour market. The rise in inflationary pressure may be dampened by soft demand backdrop Already soft demand backdrop limits the potential for secondary inflation 9
Saudi Saudi Bahrain Qatar Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Abu Dhabi Dubai GCC Economic Outlook 14 June 217 Fig. 13. GCC: Weak economic backdrop and price discounting by corporates reflected in output prices Index, a reading below 5 denotes a contraction 53 52 51 5 49 48 47 Saudi Fig. 14. : Hotels have been lowering ADRs to bolster demand in a strong USD environment % change y-o-y, average daily room rates 1 5-5 -1-15 4M215 4M216 4M217 Source: Markit Economics Source: STR Global, ADCB calculations C. Impact on domestic demand We expect to see a contraction in consumer spending in the immediate aftermath of VAT being introduced in the various GCC countries. This is the general trend seen internationally with the implementation (or increase) of a sales or consumption tax. Consumers are expected to bring forward purchases ahead of the introduction of VAT, in anticipation of the higher prices. We believe that this will be the case for high-ticket items in particular. A number of retailers are expected to offer substantial discounts and promotions in the final quarter before VAT is introduced to clear their stocks. Sales of non-perishable goods are also expected to increase in the months ahead of VAT being implemented as households look to stock up on essential items. Media reports are also suggesting that contractors are placing early orders for construction goods, even though VAT will be refundable on these inputs. This pick-up in household spending in 4Q217 is already factored into our non-oil GDP growth forecasts for the and Saudi Arabia. As noted earlier, we believe that these are the two countries that are most likely to implement VAT in January 218. For other GCC countries, the timing of VAT introduction is likely to be later with boosts in household spending not expected in end-217. Higher consumer spending ahead of VAT introduction and Saudi Arabia should see this pickup in spending in 4Q217 Fig. 15. GCC: We see s real non-oil GDP growth rising in 218 despite VAT but moderating in Saudi Arabia % change, real non-oil GDP growth 4 3 2 1 216 217 218 Fig. 16. GCC: Countries with higher GDP per capita will absorb the introduction of VAT better USD, GDP per capita 8, 7, 6, 5, 4, 3, 2, 1, - Source: Regional statistical authorities, ADCB estimates Source: IMF, ADCB estimates 1
GCC Economic Outlook 14 June 217 However, once VAT is implemented, there tends to be a sharp reversal in consumption expenditure. The time period to adjust to the new tax will depend on a number of macroeconomic variables, including the underlying strength of the economy and consumers ability to absorb the rise in prices. International examples indicate that the stabilisation period can be anywhere between six months to a year. In the GCC, we still see real non-oil GDP growth accelerating in the in 218 as Dubai-led project activity picks up despite the introduction of VAT. Moreover, the additional revenue from VAT will also be supportive of government spending, especially given the narrow fiscal deficit forecast. Furthermore, the expected classifications of VAT in the are also positive for a number of sectors. We see the looking to balance VAT revenue generation with maintaining support for a number of key sectors. The fact that residential properties (rental and sales) will likely be exempt and the first sale of residential properties will be zero-rated, will be very positive for property developers and contractors. If the standard 5% rate is applied to residential properties, we would expect to see a dampening in real estate demand and especially sales. However, we estimate that if the standard rate is applied to residential properties, this could generate another.4% of GDP to government revenue. We note that the Dubai Land Department has already doubled its property registration fee to 4% of the sale value in 213, partly aimed at limiting flipping and containing price volatility. However, in the case of Saudi Arabia, we expect to see a deceleration in real non-oil GDP growth in 218 linked to VAT. So far, we have not seen any meaningful signs of growth support for the economy, including the private sector stimulus package. Without some pick-up in other areas of economic activity, which we believe will have to be governmentsponsored, we even see some risks of a contraction in real non-oil GDP growth in 218. This is especially if Saudi Arabia progresses with other planned fiscal reforms in 2H217. Moreover, the possibility of Saudi Arabia having the broadest VAT base will also impact its recovery time, especially given the weakness in the underlying economy. The further rise in the expat levy (individuals and corporates) in 218 will also dampen domestic demand. Generally, in the GCC, we believe that countries with higher GDP per capita (, Qatar and ) will be able to absorb VAT more easily than those with a lower ratio (Bahrain, and Saudi Arabia). We also expect to see an impact on corporates as well, though most of the burden will be on the consumer. Companies will also have to adjust to the new VAT regime, which will impact most areas of business operations. VAT has the potential to impact margins and pricing strategies. As noted earlier, companies will not be able to pass on all VAT charges to the consumer, especially given the already soft domestic demand backdrop. As a result, we see corporates generally continuing to look to cut costs and maintain margins. This will likely continue to keep the labour market weak across the region. Notably, VAT can also effect businesses cash flows due to the time difference between paying and reclaiming the tax. Macroeconomic factors will determine the adjustment time recovery likely quickest looking to balance revenue growth with support to key sectors Saudi Arabia forecast to see a softening in non-oil activity in 218 Corporates will also feel an impact, especially given soft domestic demand environment 11
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