Chairman, KPMG Saudi Arabia AS oil prices increase or decrease, inflation follows in a similar direction, primarily due to oil being a significant input in a country's economy and used in critical activities such as transportation and heating. In Saudi Arabia, where oil is the primary source of income, global oil price shocks have a comparatively lesser impact on inflation compared to changes in domestic energy prices. However, the inflationary impact of higher local energy prices is likely to be considerable. For a given increase or adjustment in energy prices, the higher the share of energy products in the consumption basket (typically captured by their weight in the CPI), higher are the first-round effects on headline inflation. This relationship between oil prices and inflation rate started to retreat after the 1990s. In Saudi Arabia, this was apparent during the oil price run-up from 1999 to 2005, when the annual price of oil increased to $54.4 from $17.7. During this same period, inflation climbed to 0.5 per cent from -1.3 per cent. From 2010 to 2014, government revenues from oil and gas increased relatively faster than revenues from other (non-hydrocarbon) sources, alongside an increase in government expenditure. This exposed the Saudi economy further to oil price volatility. The fiscal pressures were not uniform, which limited the fiscal adjustment options available. The Kingdom has been providing energy subsidies since the 1970s. However, during 2015–2016 (first phase) and 2017–2018 (second phase), there was a remarkable change in subsidies with the introduction of the energy price reform, as global oil prices started falling substantially from June 2014. Energy subsidies enabled the government to provide cheap domestic energy prices to protect household income, increase the competitiveness of energy-intensive industries (such as petrochemicals) and attract foreign and domestic investments. But, the low domestic energy prices resulted in an increase in budget deficit and caused the government to spend SR 300 billion on subsidies in 2015. In the first phase reforms, retail diesel prices were raised from $0.067 per litre to $ 0.12 per litre, representing a near 80 per cent increase. Furthermore, industry diesel prices increased from about $9 per barrel to approximately $14 per barrel. The government also raised electricity prices. While the first phase of energy reform was estimated to have minimal impact on inflation, the second phase of reforms consisted of steady changes in energy prices from 2017 to 2019. High-grade and low-grade gasoline prices increased by 127 percent and 83 percent, respectively. Although prices for energy products increased from a very low base and were still significantly below international levels, they represented a major policy change. That said higher energy and electricity prices, alongside the introduction of value-added tax in 2018, were estimated to have fed into the costs of goods and services, which rely on fuel for production and transportation, exerting a strong upward pressure on inflation. As a result, CPI inflation increased to reach 2.5 percent in 2018. However, the IMF projected inflation to decrease to -1.1 percent in 2019, before stabilizing at around 2.1 percent over the medium term (2020–2021). Going forward, despite a budget surplus in the first quarter of 2019, the IMF expects fiscal deficit to rise to 7 per cent of the GDP this year. As stated by the government, energy prices are likely to be increased gradually to reach benchmark levels by 2025. The authorities have also indicated that they are considering periodic adjustments to prices that are at benchmark levels. Moreover, cross-subsidies in the energy sector that stimulates consumption are also underway.
