With a number of external challenges, Mena Fund Manager looks at some of the main issues facing the Omani economy and asset management sector

GCC countries have been unable to escape the impact of lower oil prices over the past year. While countries such as Saudi Arabia and the UAE have been able to weather lower prices, supported by more diversified economies and large currency reserves, smaller producers have been particularly affected.

Oman, one of the GCC's smaller economies, has a large exposure to the oil and gas industry making it more susceptible to lower prices. A report by Deutsche Bank Research earlier this year noted that Oman was "highly dependent" on oil and gas revenues which accounted for 52% of GDP, 90% of government revenues and 67% of merchandise exports.

A higher breakeven price than its larger neighbours, has put it under greater pressure than peers in the region.

The economy had been forecast to grow by 4.6% in 2015 before falling to 3.1% in 2016. However, sustained lower oil prices have continued to put pressure on economies throughout the region.

Indeed, Omani authorities were forced to announce a cut to proposed spending plans in 2016, while ratings agencies have also warned on the outlooks for the economy should lower prices persist. Economists have suggested that authorities might yet raise taxes in a bid to help balance the budgets.

"The decline in oil prices is expected to push Oman's fiscal and current account balances to deficits from 2014/15," the IMF noted in May. "The increase in total spending, particularly during 2010-14, mainly in response to social demands, has pushed the breakeven oil price to $108 per barrel in 2014.

"Ongoing efforts to pursue economic diversification are becoming more critical in the lower oil price environment."

Adding to uncertainty about the Omani economic outlook has been the issue of succession of ruler Sultan Qaboos bin Said. Since the accession of the sultan to the throne in 1970, Oman has seen a sustained period of stability and prosperity. However, reports of recent ill health have posed questions over the succession plan for the sultan who has no children.

Economic diversification

The sultanate has taken a number of steps towards establishing a more diversified economy in recent years. Its Oman 2020 Vision plan has aimed to create a more balanced economy, while proposals for the next 20-year plan are likely to be highly influenced by the current economic environment.

In common with other countries in the GCC, Oman has focused on driving growth outside of the oil & gas sector, looking for other potential areas of growth.

"The government has made conscious and continuous attempt at promoting other sectors such as tourism, hospitality, real estate and banking over the last few years with the view to ensure that the nation does not depend essentially on oil & gas industry," says Bruce Palmer, partner at international law firm Curtis.

Oman's growing reputation as a tourism destination and the development of its services sectors have helped.

Yet, the economy also faces several challenges. Like many other countries in the region, Oman saw protests at the height of the Arab Spring in 2011. Protests centred on a number of issues and led to greater reforms, including the introduction of a minimum wage, more civil service jobs and greater social security benefits.

Omanisation of the industry has been a key trend over the past couple of decades, with authorities offering special treatment for companies who meet minimum requirements. It has led to greater participation in the private sector for Omanis, although expats remain dominant. The Omanisation process can often throw up some difficulties for companies.

"In our view the biggest challenge for incorporated entities in today's environment is to meet and maintain the Omanisation requirements set out by Ministry of Manpower," says Palmer. "It is also important to note here that the minimum monthly gross salary of an Omani employee has been increased to OMR350 [$909], thereby making it hard for smaller businesses to stay financially viable."

Performance issues

One challenge faced by Oman is in attracting investment. Foreign direct investment inflows have remained flat as Oman saw a small inflow during 2014, according to figures from the UN Conference on Trade and Development, sharply down on the previous year.

Authorities have been keen to drive up standards in the market, adopting a number of innovations to support the development of its capital market in recent months.

This year Oman's Capital Market Authority, which oversees financial regulation, introduced a new version of its corporate governance code. The regulator also introduced terms ordering disclosure of unaudited annual and quarterly initial statements for listed companies within 15 days of the end of the quarter via the Muscat Securities Market (MSM).

"The regulatory and legal environment for foreign investors has pretty much been the same over the years," adds Palmer. "A limited liability company is the most preferred vehicle for foreign investment. A foreign company can own shares in an Omani registered company to the extent of 70%."

Perhaps the biggest challenge in attracting investors has been the performance of the market against a backdrop of volatility elsewhere in the region and further afield. Ongoing oil price weakness, coupled with the uncertainty about the Chinese economy has had knock-on effects for performance.

A -9.2% fall in the S&P Oman BMI Index during August contributed to a -2.1% drop for 2015. The index was flat during 2014 rising by 0.7% after double-digit returns in 2013. The index has failed to reach the heights of 2008 but has performed strongly since the economic downturn that shook the whole region.

"Until mid-July, Oman appeared to have decoupled from the regional market somewhat this year and was following more local fundamentals," says Tim Edwards, senior director for index investment strategy at S&P Dow Jones Indices. "Then, with China's economy stuttering, the year turned rapidly for the worse.

"The continued collapse in oil prices also generated particular volatility and weakness for the Middle East region. And with round two of the 'taper tantrum' - i.e. capital flight in anticipation of a US fiscal tightening, well underway - there were stormclouds hovering throughout less developed markets."

He adds: "Countries with a welltrusted currency peg to the US can expect some degree of shelter from the storm and Oman has one; it seems to have helped - a bit - along with less dependency on energy revenues compared to regional competitors.

"However, since July, Oman's performance has followed the global weakness in equity markets much more closely."

"It's been hard but you have to remember oil prices came off in December," says Idris Kathiwalla, acting head of asset management at Oman Arab Bank's investment management group. "At that point when it hit $50-$60 per barrel, the rest of the regional markets ran up very strongly: Saudi Arabia, Dubai and Abu Dhabi. Oman didn't up as strongly, one reason for that was the lack of liquid stocks.

"As a result of which when oil prices have sold off again and the meltdown in China you didn't see the decline you saw in Saudi Arabia or Dubai." He adds: "Oman's index has a significant proportion of defensive stocks and as such they tend to carry low beta and less systemic risk and that tends to protect the overall value of the index.

"There is liquidity issue in the market. We don't have a critical mass of liquid stocks in the market," says Kathiwalla. "A lot of the funds are invested in illiquid names. The focus is on fundamental research and ensuring the companies are fundamentally sound."

He adds: "Having said that because it is not liquid. you don't see a lot of the systemic risk that comes along with a meltdown in Oman because you don't have many sellers. The stocks don't crash."

Growing the industry

For the asset management industry there have been a number of developments aimed at encouraging interest. The MSM has taken steps to increase public awareness of investment, the activities of the exchange and its importance to the economy.

Kathiwalla says the local sector remains focused on pension funds and sovereign wealth funds, which represent the biggest source of inflows to the industry.

"The asset management industry is nascent and mainly centres around clients who are more focused on pension funds and the big corporations," he explains. "It's not so much individuals as you would find in a more mature wealth management industry."

The local asset management industry, he says, is dominated by the investment arms of the sultanate's larger banks, such as Oman Arab Bank, Bank Muscat and National Bank of Oman.

"There are a couple of asset managers who are standalone but there presence is largely limited," adds Kathiwalla.

However, future developments could lead to further sophistication of the Omani investment industry.

In its most annual report for 2014, published earlier this year, the MSM noted that it had signed an agreement with NYSE Technologies for a new trading system to commence trading in 2017. The new system would enable the local exchange to prepare for trading in derivatives, options and ETFs. It could also help the MSM provide other services such as risk management, IPOs and securities lending.

Looking ahead there are other potential developments for Oman's financial services industry. Introduced in 2012, Islamic banking has continued to gain traction in Oman, with total assets having increased by 68.2% between 2013 and 2014 to around OMR1.4bn ($3.6bn), according to the Central Bank of Oman.

"Although Islamic banking is not a development which has taken place in the last 12 months but Oman's financial industry has witnessed a substantial increase of transactions in Islamic banking and financing," says Palmer.

The greater importance of Islamic banking and finance in Oman was highlighted earlier this year as the government took tentative steps towards a sukuk issuance before proposals were sent back for further consideration, according to reports.

© MENA Fund Manager 2015