Banker Middle East considers how the world’s oldest independent Arab state must adapt to a new world.
The only thing worse than being talked about is not being talked about, as Oscar Wilde noted. Oman’s glamorous cousin Dubai has lapped up the world’s attention for years while Saudi Arabia’s young Crown Prince has hogged the headlines by shaking up the old order. Oman, which has the lowest GDP per capita of any GCC nation, has enjoyed a quieter life; but with low oil prices as the new normal it cannot afford to be outdone for much longer.
Oman has long been dependent on its modest oil reserves, which are the 25th largest in the world. Oman has been making efforts to diversify its economy since a slump in oil prices back in the ‘90s, however progress has been too slow to shield it from oil’s most recent slide. 2018 will mark the halfway point of Oman’s ninth five-year development plan, which was the last of the series of five-year plans for the Vision 2020.
The Government plans to play to Oman’s natural strengths, including the country’s enviable location, and beef up manufacturing, transportation and logistics, tourism, fisheries and mining to reshape the economy for the 21st century. Oman has one of the most diverse landscapes of the GCC, and it has been successfully luring an increasing number of tourists from around the world. In 2017, the World Travel & Tourism Council named Oman as one of the fastest growing tourism destination in the Middle East. Oman’s tourism industry may become the country’s most vital asset as it stems oil’s contribution to the economy. Among its prudent targets, Oman wants oil to contribute just 30 per cent towards its GDP before 2020, down from 44 per cent at the end of 2015.
While these plans have been declared sound by many impartial observers, continued low oil prices have left deep fiscal scars. Compounded by participating in OPEC oil production cuts in 2017, protracted low oil prices and fiscal austerity continue to weigh on Oman’s economy. Fiscal and current account deficits remain large, according to the World Bank, and with Oman increasingly resorting to external borrowing to finance its deficits, public debt is rising rapidly. Oman struggled to reign in its spending last year. Government spending cuts fell short of targets in the first half of the year, according to Fitch Ratings.
Data showed a six per cent decline in total government spending in the first seven months of 2017 compared with a year earlier, with a year-on-year decline of 26 per cent in July alone. The authorities took important policy measures in 2016, including fuel price reform, to address the impact of lower oil prices on government finances, but implementing the budget proved challenging. The combination of lower oil prices and higher spending has resulted in a widening of the budget deficit to around 22 per cent of GDP, according to the International Monetary Fund (IMF).
S&P estimates that Oman’s net external asset position has materially declined to 30 per cent of current account receipts in 2017, from 60 per cent in 2016. The ratings agency also estimates that Oman’s fiscal and current account deficits were higher in 2016 than it had anticipated, and GDP per capita lower. “Based on our projections for continued sizable current account deficits, we expect Oman to be in a narrow net external debtor position of 12 per cent in 2020,” the rating agency said. “Due to oil prices remaining relatively low and Oman’s dependence on the hydrocarbon sector for export receipts (60 per cent of total exports in 2016), we expect large current account deficits above ten per cent of GDP in 2017 and 2018, before they gradually decline to six per cent of GDP in 2019 and 2020.”
According to Moody’s Investors Service, the government’s tighter purse strings could paralyse Oman’s banking sector, as its capacity to support the country’s banks will be limited and liquidity conditions will be tightened.
“We expect a softening in Oman’s operating environment, with fiscal consolidation amid prolonged oil price weakness weighing on economic growth,” said Mik Kabeya, Analyst at Moody’s. “This will weigh on credit growth, which we forecast to fall to five per cent in 2017, down from 10.1 per cent in 2016 and 12 per cent in 2015.”
Slower economic growth will drive a marginal weakening in problem loans to around three per cent of gross loans in 2017-18, from 2.1 per cent at end-March 2017, according to the rating agency. Moreover, high concentrations of loans to single borrowers and to the realestate sector pose downside risks to asset quality. However, Moody’s expects capital to remain sound, providing strong loss absorbency. Moody’s forecasts systemwide tangible common equity (TCE) to range between 12 to 14 per cent of riskweighted assets over the next 12 to 18 months. Even under the rating agency’s low probability 'stress test' scenario, the TCE ratio would remain a solid 10.3 per cent. Profitability will decline slightly.
Net interest margins will likely remain stable at around 2.4 per cent over the outlook horizon (2.4 per cent in 2016) as higher lending rates offset increasing funding costs, while loan loss provisioning will increase somewhat as problem loans rise. Funding and liquidity conditions will remain tight, as high domestic government borrowing limits funds available to lend to the wider economy. Nonetheless, the government’s international bond issuances, slower credit growth and higher oil prices will moderate the pressure.
Finally, although the Government’s capacity to support banks if needed will reduce, the rating agency notes that willingness to provide support will remain very high. Allison Holland, Division Chief Regional Studies, Middle East and Central Asia Department, International Monetary Fund, said, “The Omani banking system remains well capitalised, deposits have increased, liquidity conditions appear to have eased, and credit to the private sector continues to grow. “Interest rates are likely to increase as US monetary policy tightens further.
Gross reserves of the Central Bank of Oman increased in 2016 from $17.5 billion to $20.3 billion and are considered adequate on a number of metrics. The exchange rate peg to the US dollar continues to serve Oman well given the current structure of the economy.”
Optimism for Oman
There is certainly some cause for cheer. Oman’s GDP growth is expected to rise to 5.2 per cent next year, according to a recent report from Cluttons, aided by the introduction of natural gas production at the Khazzan gas field and the opening of the new airport in Muscat. This will mark the strongest rate of expansion since 2015. Fitch noted that revenues increased 26 per cent year-on-year in the first seven months of 2017, reflecting some recovery in oil prices, and revenues will be further supported in 2017-2019 by the recent start of production from the Khazzan gas field. A review of corporate tax exemptions and an increase of tax rates will begin to have an impact in 2018, while new excise taxes could be introduced soon and VAT in late 2018.
Fitch’s 2018 deficit forecast for Oman stands at 10.9 per cent. It expects the country’s 2019 fiscal deficit to narrow to 9.8 per cent of GDP. “Continuing deficits mean we forecast debt to rise to 48.2 per cent of GDP in 2019,” the rating agency said. “We estimate Oman’s fiscal breakeven oil price at $75-85/ bbl even with planned spending cuts and non-oil revenue measures.”
Oman has financed its deficits mostly through foreign debt issuance, accompanied by drawdowns from the State General Reserve Fund of Oman (SGRF). SGRF foreign assets were $18 billion at end-2016, underpinning Oman’s sovereign net foreign asset position and supporting its market access and exchange rate peg. In a hypothetical scenario where Oman did not issue debt and maintained fiscal deficits at forecast 2017 levels, SGRF assets would be depleted by the end of 2018, Fitch said. But they could last considerably longer if accompanied by debt issuance, fiscal consolidation, and favourable asset returns.
The Government is also hoping to privatise some of its domestic infrastructure assets. “The authorities recognise that the sustained decline in oil prices underscores the need to undertake sustained fiscal adjustment, accelerate economic diversification, and increase the role of the private sector to stimulate the economy,” Holland said. “Economic growth moderated in 2016 to about three per cent, from 4.2 per cent in 2015, with non-hydrocarbon growth slowing from 4.2 to 3.4 per cent given the continued impact of low oil prices.” The IMF expects non-hydrocarbon growth to average about 3.5 per cent over the medium term.
The IMF noted that improving the business environment, including by streamlining regulatory processes and increasing the level of vocational skills, will support efforts to increase private sector employment. “Steadfast implementation of the budget will protect policy credibility and sustain investor confidence, which has underpinned Oman’s access to international financing at favourable terms over the past year,” Holland said. “Over the medium term, timely implementation of the increase in corporate income tax and planned introduction of VAT and excise duties will underpin a continued improvement in the fiscal position. The current account deficit, estimated at 17 per cent of GDP in 2016, is also expected to decline.”
While Oman’s economic reforms have been warmly received, implementation will be difficult if a fresh fall in oil prices pulls the government’s purse strings even tighter. By contrast, a fair wind and improved oil prices could reduce the country’s debt and stabilise the government’s debt/GDP ratio. Oman’s position therefore remains precarious but pointing in the right direction.