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Fri 29 Jan 2016 10:47 AM

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Oman: where to now?

It is a catch-22 situation: Oman’s reliance on hydrocarbons for about 80 percent of its state revenues amid a ‘new normal’ of low oil prices means diversification is its top priority. But small fiscal reserves are making the task significantly harder

Oman: where to now?

Oman’s cabinet is no doubt  in fraught discussions at present. The sultanate — one of the most heavily hydrocarbons-dependent of the GCC states — is grappling with the impact of the sinking oil price on its national coffers and the outlook for the country is bleak.

The government expects to run a deficit of OMR3.3 billion ($8.6bn) this
year, according to its latest budget announced this month. The figure
represents 38 percent of total estimated government revenues, of which hydrocarbons
last year accounted for 78 percent.

The sultanate has been especially hard hit by the sharp decline in oil prices from $100 per barrel 18 months ago to below $30 today. Oman’s 2015 oil revenues were down 24 percent on the previous year and, although non-oil revenues are predicted to grow from $3.9bn in 2015 to $6.36bn in 2016, total revenues are expected to drop by another 4 percent.

Macroeconomic challenges, including the Chinese slowdown, regional conflict and the US Federal Reserve decision to hike interest rates from 0 percent to 0.5 percent at the end of December, are placing additional pressure on Oman.

Rating agencies have downgraded the outlook for Oman from ‘stable’ to ‘negative’, citing downward pressures on economic growth due to low oil prices and the sultanate’s relatively undiversified economy when compared to other GCC states.

Trevor Cullinan, director of Standard & Poor’s sovereign ratings group, tells Arabian Business: “We lowered the ratings on Oman twice in 2015, to ‘A-’ from ‘A’ in February, to ‘BBB+’ in November, as our assumptions about oil prices fell further and Oman’s fiscal and external balances deteriorated beyond our initial expectations.

“The negative outlook reflects our view that the government’s fiscal and external positions could fall beyond our current expectations over the next two years.

“Consequently, we could assess Oman as having insufficient fiscal and external strength to offset the concentration of its economy in the hydrocarbons sector and the resulting volatility.”

The government intends to narrow the deficit by cutting public spending by 11 percent year-on-year, as well as slashing subsidies by 62 percent, deregulating fuel prices, raising corporate tax and increasing fees on government services. Oil and gas production is cut by 13 percent in the 2016 budget and investment and development spending by 17 percent.

The government has also unveiled a five-year strategy to halve the contribution of oil to the economy from 44 percent of gross domestic product (GDP) to 22 percent by 2020, and of natural gas from 3.6 percent to 2.4 percent, with programmes focusing on manufacturing, mining, transport and tourism in particular.

The new plan is to make heavy use of public-private partnerships, with 52 percent of total investment to come from the private sector, against 42 percent in the last economic plan.

These are significant adjustments, but analysts warn Oman has a rocky few years ahead as it tries to balance the books and make the shift away from oil dependency.

Oxford Business Group’s Middle East managing editor, Oliver Cornock, says Oman is highly vulnerable. “Unlike many of its Gulf neighbours, Oman does not have the same vast financial buffers in place to weather a sustained period of low oil prices.”

Cullinan agrees: “Sizeable oil receipts in past years helped Oman to build up government liquid assets, which we estimate at about 50 percent of GDP in 2016.

“However, other oil-dependent GCC economies with stronger ratings, such as Abu Dhabi, Kuwait, Qatar and Saudi Arabia, have larger hydrocarbon endowments and accumulated a higher level of assets, which they are now able to utilise to offset the decline in oil prices.”

In recent years, Oman has kept public spending high to finance large-scale infrastructure projects and expand its workforce. But as these projects have been funded in large part from its oil revenue-laden reserves, plummeting oil prices will place a significant strain on the country’s ability to invest in diversifying its economy, experts say.

“The government’s expansionary fiscal policy over the last several years has been critical to boosting domestic demand and financing large capital spending projects in a variety of sectors,” IHS Middle East and North Africa economist Patrick Schneider says.

“After trying to ride out the storm in 2015 with only minor adjustments, Oman will begin enacting significant austerity measures targeting lower expenditures and higher non-oil revenues.

“This means the fiscal balance is likely to deteriorate sharply over the next two to three years, with non-hydrocarbon growth slowing as government spending falls.”

Schneider adds: “Mitigating factors, such as lower imports and slower remittance and profit repatriation, will ease some of the strain on the current account, and economic growth should receive a modest boost from gradually rising hydrocarbon production, both oil and gas.

“However, lower investment expenditures may weigh on the sovereign’s ability to boost production as previously hoped. All in all, domestic demand will slow considerably in 2016 and is likely to remain subdued in 2017 as the expansionary fiscal environment may not return for some time.”

Another drag on growth is reduced spending elsewhere in the Gulf — in particular from Saudi Arabia and the UAE — which could negatively impact external demand for Omani goods and services, Schneider says.

Mathias Angonin, an analyst at rating agency Moody’s sovereign risk group, says the worsening fiscal and economic situation has already started to affect corporates, with government and government-related entities delaying payments to suppliers.

“In January, the government approved an increase in corporate tax from 12 to 15 percent as well as levying all companies operating in Oman,” Angonin says. “The 2016 budget projects significant subsidy cuts to $1.04bn, down from $2.86bn. All citizens will be affected by gasoline price increases.

“Meanwhile, the slowdown in new public sector jobs means youth unemployment will grow. Real estate and construction should be spared because the government intends to press ahead with a number of strategic capital projects.”

Those projects include a new economic free zone at the Port of Duqm, the redevelopment of Muscat Airport, the expansion of Khazzan gas field, a new power plant at Sohar and the Liwa Plastics Industries Complex.”

Matthew Green, head of research & consultancy UAE at CBRE, agrees that any detrimental impact of tough economic conditions on Omani real estate has yet to be felt. In fact, he says, total real estate transactions were up 41 percent in 2015 compared to the previous year; the total value of traded real estate in the sultanate had reached $8.8bn in October, according to figures from the National Centre for Statistics and Information (NCSI).

“Like much of the Middle East region, Oman is facing mounting challenges as low oil prices impact upon the local economy, bringing with it a raft of government spending cuts,” Green says. “However, to date, the impact on the real estate sector has been quite limited with a lag period seemingly occurring.

“There are a significant number of new real estate projects being considered by the public sector, and while private sector involvement remains constrained there are some signs that this could start to change.”

However, rents had started to drop by the end of last year and CBRE predicts residential sales prices will slide over the coming months. “Rental rates in Muscat saw some minor deflationary pressures emerge during the second half of 2015, and this trend is expected to continue through 2016 as economic growth slows and job losses become more prevalent.

“A similar trend is forecast for both the residential and commercial sales markets, with investor sentiment following the economy lower with greater uncertainty shrouding the short to medium term outlook.”

Earlier this month, the government signed a $1bn loan agreement with 11 international banks to partly fund the $8.57bn budget deficit in the medium term. It intends to fund the rest with $3.9m of reserves, $1.56bn of grants and $779m of local borrowing.

Finance Minister Darwish Bin Ismail Al Balushi said at the time: “It is better to borrow from overseas markets than depend on domestic market for funds since it will not affect local liquidity.”

In the medium term, the government is pressing ahead with planned subsidy cuts on water and electricity, and other fiscal reforms. It is also expected to introduce a value added tax (VAT) by 2018 along with the rest of the GCC.

“Such tax hikes and cost-cutting measures indicate the government’s commitment to — admittedly unpopular — measures necessary to deal with the significant drop in oil revenues,” Cornock says.

“In some ways, the current climate is enabling the government, and other countries in the region, to press ahead with reforms to subsidy systems that economists have identified as unsustainable for years. Public awareness campaigns focusing on efficient use of energy will be crucial to ensuring Oman can successfully wean itself off cheap, subsidised energy.”

Oman is taking other steps to shore up its economy. In October, it raised $873.9m on its first sovereign sukuk, a $520m, five-year bond. The fact that it was so oversubscribed bodes well for future sukuk issuances; the government is expected to issue another this year.

However, Cornock argues the country could do more. “Further privatisation of state-owned firms is another option for the government as it seeks to boost revenues.

“Also, local reports have indicated that the government is planning to divest stakes in as many as 11 state-owned firms via initial public offerings (IPOs). This would follow the most recent such move in April 2014, when the country raised $624.2m from the sale of 19 percent of state telco Omantel on the Muscat Securities Market.”

Schneider says slashing public sector wages would be a helpful move. “Civil service employment is a huge burden on the fiscal accounts, with wages and benefits alone costing about 10 percent of GDP.

“Restraining any further salary increases and allowances or additional hiring would be a positive — though it must be taken into account that the public sector remains important for political stability and employment for native Omanis.

“The government has said it will review various ministerial expenditures, from car allowances to energy efficiency, which would be a positive development for all Gulf states where government spending is quite inefficient and frothy.”

Schneider says the government should also seek to improve the domestic business climate by helping small-to-medium-sized enterprises (SMEs) overcome bureaucratic hurdles and up-skilling the labour force, given that the margins for sustaining growth under a low oil price environment are much smaller. “Corruption and petty bribery remain an issue at local level,” he adds.

Still, unemployment levels, which have persisted at about 10 percent or more for the past decade, are expected to increase further in 2016, according to Pat Thaker, MENA regional director at the Economist Intelligence Unit.

She says Oman’s real GDP growth forecast for 2016 stands at 2.1 percent, “because of the weak oil price and extensive austerity plan the government is implementing”.

The measures being taken are positive medium-term fiscal strategies designed to ensure stability in the new oil price environment, but Oman could take some time to adjust.