|26 May, 2019

Corrected: Oman outlook: Sovereign debt continues to climb as pace of change remains slow

Public debt has ballooned from an average of 11.8 per cent of GDP in the years between 2000 and 2015 to 50.9 per cent in 2018

Image used for illustrative purpose only. Sunset view over Muttrah, one of the old parts of Muscat, Oman.

Image used for illustrative purpose only. Sunset view over Muttrah, one of the old parts of Muscat, Oman.

Getty Images/Marc Guitard

(An incorrectly attributed quote in the 32nd paragraph was removed).

Illuminated in an eerie blue light as they float past coral, the fish swimming around Muscat's newest visitor attraction may not be enough to reel in the punters and steer Oman's floundering economy away from the rocks.

For the tourists frequenting the vast Oman Aquarium which opened in April, even the presence of diving turtles and penguins cannot disguise the fact that many of the shops in the surrounding Mall of Muscat remain boarded up.

Property brokers say that many retailers are waiting to see how difficult trading conditions, driven by a sluggish economy and declining expat population pan out this year before taking the plunge. 

“Market conditions continue to be soft overall,” says Adam Fitzpatrick, associate partner for business development in Cavendish Maxwell's Oman office. “Retail sales are declining and sentiment is weaker.”  

He expects shop rents for the best stores in Muscat to fall by 10 percent in 2019 alongside rents for the best offices and residential villas in the city. Meanwhile, residential apartment rents will be hit hardest of all, slumping 15 percent before the end of 2019.

“Most of this downward pressure on the property market is due to sluggish economic growth,” Fitzpatrick says. “Oman's economy is not insulated from global trade tensions and challenging market conditions, much like its regional neighbours.”

Like many of its Gulf neighbours, Oman was hit hard by the global slump in the price of oil five years ago which, in the course of just a few months, saw receipts from the country's key export plummet.

According to the International Monetary Fund, the country fell into recession in 2017 with real GDP falling 0.9 per cent in 2017, before growing slightly by 2.1 per cent in 2018. The IMF predicts GDP growth will stand at just 1.1 per cent this year as oil production cuts continue to weigh heavily on the economy. 

On the ground that has translated into fewer expat jobs, less spending in the shops and pressure on rents and prices.

Faced with a dramatic slump in revenues from its main export, the sultanate was suddenly put in a position where it could no longer afford to pay the large public spending commitments it had made during the boom times.

But, rather than cut public spending, Oman, like other Gulf economies attempted to borrow its way through the tough times by issuing billions of dollars of government bonds.

Spiralling debt

IMF data shows that public debt in Oman has mushroomed from an average of 11.8 per cent of GDP in the years between 2000 and 2015 to 50.9 per cent in 2018. And this proportion is projected to get even bigger this year, growing to 61.3 per cent in 2019 and 63.1 per cent in 2020.

At the same time, the country has bond repayments of US$4.3 billion falling due in 2021 and US$6.4 billion due in 2022, which could significantly eat into its foreign exchange reserves.

Last year Saudi Arabia and the UAE were forced to pledge US$10 million bailing out Bahrain which had seen its public debt grow to nearly 93 per cent of annual economic output after its economy was put under strain from a similar set of issues.

Now, with the pressure off Bahrain, ratings agencies have been turning their attention to Oman as the GCC economy most likely to default on its bonds.

As a result, Omani bond yields have increased significantly. Currently five year Oman bonds are yielding around 5.5 per cent and 10 year bonds are yielding around 6.75 per cent. New bonds are expected to attract even higher yields.

In March Moody's Investor Service became the last of the big three ratings agencies to downgrade Oman's bond rating to 'junk' based on the country's worsening economic outlook. Moody's lowered the country to Ba1 – one notch below investment grade – with a negative outlook, making it more expensive for the sultanate to borrow from international markets.

Then, in April, S&P went even further, cutting the outlook for Oman's long and short term sovereign debt to 'negative’, while continuing to class Omani bonds at BB - two levels below investment grade.

According to S&P, the country's external debt will exceed its assets by an average of about 50 per cent over the next four years.

Zahabia Gupta, associate director for sovereign ratings at S&P, said she expected Oman's “still-sizeable” fiscal deficits to continue to increase through 2022. “In our view, the debt structure is vulnerable to a sharp decline in foreign investor confidence in Oman, particularly as large Eurobond maturities loom,” she said.

Analysts worry that Oman has done little to diversify its economy away from oil production. According to the IMF, the country's non-oil revenues stood at 11.5 per cent of GDP in 2016 and grew to just 12.4 per cent in 2017 – the same proportion it is expected to produce this year.

David Rogovic, assistant vice president – analyst for Moody's, said Oman's “persistently wide fiscal deficits will contribute to wide current account deficits, perpetuating Oman's dependence on steady inflows of external financing and denoting material external vulnerability.”

Like other Gulf economies, the biggest ticket item on its books is the huge salaries it pays vast staffs of Omani nationals employed by government companies. Citizens also benefit from generous government handouts.

“From our side we are still worried about the economic situation in Oman,” says Sergey Dergachev, senior portfolio manager at Frankfurt-based investment bank Union Investment Privatfonds.

“Oman needs to reduce its public sector wage bill, support more privatisations, reduce youth unemployment and diversify its economy away from oil dependency. But politically, and most importantly socially, it is still a very difficult challenge, since it will most likely affect the day-to-day life of Omani citizens.

“The big question mark hanging over Oman is the political succession. The biggest challenge for any successor would be to win the approval and respect of all the different tribes in the country,” he adds.

To make matters worse, unlike Saudi Arabia and the UAE, Oman has still not implemented its planned value added tax on goods and services, preventing it from benefitting from another possible revenue stream.

Reform required

“Fiscal and structural reforms are needed in order to improve the worsening economic situation,” says Mohammad Ahsan, managing director for rates and fixed income at Mashreq Bank. “VAT is under consideration for 2020. But unlike the UAE and Saudi Arabia, the pace of reforms is slow in other GCC countries including Oman. Another option for Oman is to privatize state owned entities, a plan which remains on the table.”

One of the key planks in Oman's strategy to diversify its economy is for the country's tourism industry to attract 11 million visitors to the country each year by 2040.

But even visitor numbers have been hit by the oil slump. According to official figures, the number of tourists visiting Oman fell from 3.2 million in 2017 to around 3 million last year. Oman's Ministry of Tourism blamed the drop in numbers on “a moderate reduction in the number of cruise ship passengers and GCC nationals visiting Oman”.

Property brokers point out that as well as a drop in tourist numbers, Oman is also experiencing a dip in the number of expats living in the country as a result of both the economic slowdown and Oman's recent freeze on issuing new visas for some expats.

“There has been an erosion of the number of expatriate professionals in Oman since 2015,” says Ihsan Kharouf, head of Oman for Savills.

Another concern is the political landscape of the six-state Gulf Cooperation Council which has shifted over the last two years since the UAE, Saudi Arabia, Bahrain and Egypt imposed a land and sea blockade on Qatar. Rather than take sides with the UAE and Saudi Arabia, Oman has remained politically neutral. The country has also played a key role in negotiating with Iran, despite growing regional tensions between Iran and Saudi Arabia.

All this could mean that Oman's rich neighbours might not be so quick to provide financial aid - or could do so only if the country agrees to meet certain economic or political conditions.

But for now it seems that a crisis for Oman may be averted. After crashing dramatically from well over US$100 a barrel in 2015 to a low of less than US$30 at the start of 2016, oil prices have been slowly been recovering to hover around the $70 per barrel mark.

At the same time, according to the IMF, Oman's fiscal break-even oil price – the price at which the country is able to balance its books - has fallen from $101.10 a barrel in 2016 to a predicted $85.90 for 2020.

“We believe Oman can muddle through without financial assistance in 2019,” Mashreq's Mohammad. “Therefore yields on Omani bonds will remain stretched.”

And yet, Oman's underlying structural problems are not going away.

“Oman has done very little to tackle the long term structural issues which are causing its problems,” Dergachev says. “Even if the oil price recovers and Oman is able to avert an economic crisis this time, it will still remain vulnerable to further oil shocks.”

(Reporting by Lucy Barnard; Editing by Michael Fahy)

Our Standards: The Thomson Reuters Trust Principles

Disclaimer: This article is provided for informational purposes only. The content does not provide tax, legal or investment advice or opinion regarding the suitability, value or profitability of any particular security, portfolio or investment strategy. Read our full disclaimer policy here.

© ZAWYA 2019

More From GCC