Strong economic growth and the government's focus on diversifying the economy will also contribute to the expansion, according to the Sico Investment Bank study.

Economic growth, improved liquidity and the restructuring of the sector have led to robust growth in the past few years. Overall profits of Oman's banks have grown at an average of 39 per cent during the past three years from OMR79.4 million (Dh757.7m) in 2004 to OMR213.7m in 2007.

"Oman's economy has experienced strong growth in both oil and non-oil based sectors in the past few years, thanks to the relentless rise in oil prices and higher infrastructure spending," says the report. "The average nominal GDP growth rate during the period 2004-2007 stood at about 17.4 per cent. The petroleum sector was the major contributor to this growth with an average growth rate of about 20.5 per cent while the non-petroleum sector grew steadily at 15.1 per cent."

Sico says future growth will be also be driven by the government's significant infrastructure spending plans. It cites IMF estimates that expected nominal GDP growth in 2008 will be in excess of 25 per cent due to the more than 50 per cent rise in oil prices during 2008. The current account surplus is expected to cross 11 per cent of GDP. Other significant factors include the government focus on diversification.

"The contribution of oil to the overall GDP has gradually increased from 42 per cent in 2002 to a peak of 49 per cent in 2005 and started to decline to 45 per cent last year," says the report. "Moreover its contribution towards the overall government revenues and exports is much more substantial at 62.1 per cent and 58.4 per cent respectively in 2007."

The study shows Oman's oil resources have been declining steadily during the past few years, falling to 712,000 barrels per day (bpd) in 2007 from a peak of 956,000 bpd in 2001. The proven oil reserves stood at 4.62 billion barrels at the end of 2007 and are expected to last for 18 years at current levels of production.

"The declining oil reserves and production has prompted the Omani government to focus on diversifying the economy to reduce the contribution of hydrocarbon sectors to its GDP to 20 per cent by 2020. To reach its target, the government is increasing its investments in the infrastructure and tourism sectors. Accordingly the government has announced infrastructure and tourism projects worth nearly $48.8 billion (Dh179.24bn) to be implemented during the next five years."

Sico predicts that banks will benefit from planned investments with project financing expected to constitute a large part of the sector's activities.

The report highlights monetary growth in Oman, pointing out that broad money (M2) growth surpassed nominal GDP growth during the past two years. In line with higher M2 growth, deposits and advances have also grown at an increasing pace during the past few years, averaging more than 20 per cent annually.

Record high oil prices coupled with strong growth in non-oil revenues have given a significant boost to the overall finances of the Omani government. The country has shown fiscal surpluses in the past four years and the surplus reached a record high during the first quarter this year.

Another factor is the penetration of banking services, which is low in Oman, with an average population per branch of 7,300 individuals.

"The country's population is very young with nearly 38 per cent under the age of 14 years. This young and attractive segment is expected to enter the workforce within the next 10 years, creating a large and lucrative target market for banks."

However, the report addresses major risks to the banking sector, led by any potential decline in oil prices.

"Though the government has taken steps to reduce its dependence on oil, it still contributes a substantial portion of GDP of 45 per cent and government revenue of 62 per cent. Therefore any sharp decline in international oil prices has the potential of derailing the overall economic growth and affecting the Oman government's infrastructure investment plans. However on the positive side, the current account and fiscal account surpluses at current oil prices are high enough to sustain a drop of about 25-30 per cent from these price levels without significantly affecting the economic fundamentals of Oman," says the study.

Another risk is the substantial proportion of personal loans. Sico says about 40 per cent of total loans at the end of 2007 comprised personal loans, including mortgages, loans for consumer durables and to a lesser extent educational loans.

"Some of these loans are likely to have been utilised for speculative purposes in the stock and real estate markets which are most vulnerable, especially at a time of economic slowdown."

The Sico report stresses that inflationary pressures in Oman have worsened over the past six months due to soaring demand, low interest rates, higher money supply growth and the resultant excess liquidity.

"Worryingly, the Central Bank of Oman (CBO)Central Bank of Oman (CBO) is left with few options to curtail inflation as its interest rate policy is largely determined by the US Federal Reserve by virtue of its currency peg.

"With the lack of monetary policy independence, the CBOCBO has resorted to other options like price controls, repo rates, enhancing reserve requirement and putting restrictions on lending in order to curtail inflation."

The declining lending spread poses another risk due to increased competition and the gradual decline in maximum lending rates for personal loans.

"Increasing competition for deposits to fund loan and asset book growth has caused the deposit rates to go up, thus putting pressure on margins. On the lending side, competition from foreign players has increased the efficiency and consequently pricing of the loans.

"Spreads on US dollar loans, however, have improved in the past few years due to the improved sovereign rating of Oman, which allowed Omani banks to borrow funds at a lower cost."

The report rates Bank MuscatBank Muscat and Ahli BankAhli Bank overweight and has a neutral stance on the current prices of Oman International BankOman International Bank, Bank DhofarBank Dhofar and National Bank of OmanNational Bank of Oman.

And it says this is a good time to increase exposure to the banking sector in the Oman stock market.

"The market has seen a sharp fall in prices during the past few weeks after making an impressive start earlier during the year. The banking and financial sector has been particularly hard hit during this downward trend with the MSM Banking sector index losing almost 14 per cent during the past three months as compared to about five per cent decline in the broader MSM-30 index."

The five banks covered by the report have seen a steep correction in their prices, in the range of 10 to 25 per cent, during the past two months alone, wiping out almost all the gains made since the beginning of the year.

"The long-term fundamentals of the Omani banking sector are still positive and hence we feel that the price decline should be taken as a good opportunity to increase exposure to an attractive sector," says the Sico report.

By Mohamad Al Kady

© Emirates Business 24/7 2008