The introduction of value added tax (VAT) in Saudi Arabia and the UAE has been heralded as a logistical success – but economists are warning that it may have a significant effect on wages in both countries, with employees in Dubai braced for a real terms pay cut in 2018.

Despite fears retailers might not be ready to process the tax when it came into effect on 1 January, it appears it has been introduced relatively painlessly in both KSA and the UAE. The real problems, however, may just be starting, according to a report from consultancy Korn Ferry Hay Group.

The new VAT of 5 per cent covers food, fuel, household goods, utilities and other purchases, though health, education and public transport are among a number of notable sectors granted exemptions. Saif Mohammed Al Hajiri, chair of Abu Dhabi’s Department of Economic Development, characterised it as a “positive” addition to the Emirate’s development drive and said would “ensure a robust, sustainable and diversified economy to ultimately wean the country off oil in the future.”

However, Korn Ferry said VAT will push inflation in the UAE to 4.6 per cent this year, meaning an expected 4.1 per cent average pay rise will feel like a 0.5 per cent pay cut in real terms.

Its latest pay forecast suggested employers in both countries would face a “challenging” time as the tax ate into salaries and made both destinations marginally less attractive for expats. The consultancy said it did not expect employers to offer additional wage boosts to help mitigate the increased cost of living.

Overall, however, Korn Ferry Hay Group associate client partner Harish Bhatia told The National he expected the economic benefits to outweigh such issues: “We’re all making a big deal out of VAT because it’s a new tax and we’ve never played with the word ‘tax’ in this part of the world, but it had to come and it was inevitable so the government has other sources of revenue.”

Reports predicted lower paid employees and expats from Asian countries would be most likely to feel the squeeze under VAT. And this week, Talmiz Ahmad – former Indian ambassador to Saudi Arabia, the UAE and Oman – said he expected remittances sent back to India to fall further as the tax came in. “Low paid Indian expatriates will be adversely affected,” he said. “I have a feeling that… because of the fall in oil prices and reduction in employment, the remittances have already reduced in the last two or three years.”

In Saudi Arabia, the rise in VAT has been compounded by increases in petrol prices, which have recently almost doubled as part of the kingdom’s drive to reduce oil dependency and stimulate its economy. In January, King Salman announced a monthly bonus of SAR1,000 for all government employees, for a period of 12 months, to reflect the rising cost of living.

Some have suggested VAT could be beneficial in the longer term. In November, People Management reported predictions by Robert Half UAE that the new tax could lead to increased demand for finance professionals and other forms of professional services in the country, as part of a general hiring boost thanks to large scale infrastructure projects.

And Korn Ferry Hay Group said demand for both professionals and skilled labourers in the UAE remained high, pointing out that a recent fall in rents would help offset other costs.

Other Gulf states, including Bahrain and Kuwait, have delayed the introduction of similar VAT regimes until 2019, while Oman will begin introducing VAT in selected sectors in the middle of 2018.