VAT to fuel inflation spike before moderating
The introduction of valued-added tax (VAT) across the GCC is expected to cause a spike in inflation across the region in the first few months after before moderating in the months ahead.
With some key components of the consumer price inflation basket remaining either zero-rated or exempt, the percentage point rise in inflation directly from VAT will be less than the 5 per cent tax rate, especially as residential housing tends to have the largest weighting in the inflation basket. However, while food has a high weighting, and governments are considering only a limited number of exemptions, prices are expected to surge.
“We estimate that VAT could add about 2.7 to 3.7 percentage points to headline inflation in the first year post introduction,” said Monica Malik, chief economist of Abu Dhabi Commercial Bank (ADCB).
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.”
A sudden spike is unlikely because of the price scrutiny that is expected to follow the introduction of VAT, as well as competitive pressures and a potential slump in consumer spending.
“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,” said Shailesh Jha, an economist at ADCB. “We do not expect to see any meaningful build-up in secondary inflation due to a limited rise in wages linked to the introduction of VAT and merchants being unable to raise prices by more than the 5 per cent linked to VAT.”
A contraction in consumer spending is expected across the GCC in the immediate aftermath of VAT’s introduction. This is the general trend seen internationally with the implementation (or increase) of a sales or consumption tax. However, consumption is expected pick up within a few months. International examples indicate that the stabilisation period can be anywhere between six months to a year.
Consumers are expected to bring forward purchases ahead of the introduction of VAT, in anticipation of the higher prices. This will likely 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, while sales of non-perishable goods are also expected to increase in the months ahead of its implementation.