Decline in oil prices will have significant impact on Oman’s economic and fiscal indicators: S&P

According to Standard & Poor’s ratings services, the decline in oil prices will have a significant impact on Oman’s economic and fiscal indicators given its high dependence on oil. They also forecasted that Oman’s GDP per capita will fall to $14,600 in 2016 from $20,500 in 2014, while the annual average increase in general government debt will be about 5 per cent of GDP in 2016-2019.

Standard & Poor’s Ratings Services lowered its long- and short-term foreign and local currency sovereign credit ratings on the Sultanate of Oman to ‘BBB-/A-3’ from ‘BBB+/A-2’. The outlook is stable. At the same time, they have revised their transfer and convertibility (T&C) assessment on Oman to ‘BBB’ from ‘A-’.

As a “sovereign rating” (as defined in EU CRA Regulation 1060/2009 “EU CRA Regulation”), the ratings on the Sultanate of Oman are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see “Calendar Of 2016 EMEA Sovereign, Regional, And Local Government Rating Publication Dates,” published Dec. 22, 2015, on RatingsDirect). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the reason for the deviation is the recent revision of Standard & Poor’s global oil price assumptions.

The next rating publication on Oman is scheduled for May 20, 2016, according to our calendar. In mid-January 2016, Standard & Poor’s materially lowered its oil price assumptions for the period 2016-2019. Prices for crude oil in spot and futures markets are about 70 per cent below mid-2014 levels, when prices began to slide. When we last reviewed Oman published Nov. 20, 2015, on RatingsDirect), we expected Brent oil prices to average $55 per barrel (/bbl) in 2016 and to gradually recover to $70/bbl in 2018 and beyond. We now assume an average Brent oil price of $40/bbl in 2016 and $50/bbl by2018 published Jan. 12, 2016).

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We do not expect the Feb. 16, 2016, agreement between oil ministers from Qatar, Russia, Saudi Arabia, and Venezuela to freeze output at the levels reported in January will have a material impact on our oil price assumptions. We note that the first market reaction to this news was a further decline in oil prices. On the supply side, we note that the freeze would take place at already record high levels of output for Russia and Saudi Arabia. We also note that the agreement is conditional on other producers freezing production. On the demand side, we see China’s economic slowdown and debt load as a continuing top global risk. Our long-term oil price assumptions will continue to be informed by our view of the marginal cost of oil production.

In November 2015, we said we could lower the ratings on Oman if it appeared we had underestimated the likely negative impact of lower oil prices on the economy. We now project a more material deterioration in Oman’s economic and fiscal outlook. We have therefore lowered our long-term ratings on Oman to ‘BBB-‘.

In Oman, the hydrocarbon sector accounted for just under half of GDP in 2014, slightly over half of exports, and three-quarters of government revenues. However, the hydrocarbon sector’s contribution to the economy fell to about 35 per cent of GDP over the first half of 2015 following the pronounced decline in oil prices.

Given the country’s high dependence on this commodity, we have revised our forecasts for economic growth and the fiscal and external positions to incorporate the lower expected oil prices. Since our review last November, we have reduced our real GDP growth forecasts for Oman over 2016-2019 to an average of 1.4 per cent a year from about 3.0 per cent, while our GDP per capita estimate for 2016 has fallen to $14,600 compared with the $16,300 we had expected at our last review.

We expect only a slow recovery to about $16,000 in 2019 (compared with over $20,000 in 2011-2014). We anticipate that the GDP deflator will remain negative in 2016 (-7 per cent), compared with -20 per cent in 2015. Our forecasts for the change in general government debt (which is our preferred fiscal metric because in most cases it is more comprehensive than the reported headline deficit) have also increased to about 5% of GDP compared with about 3 per cent in November. Furthermore, we now anticipate larger current account deficits, equivalent to 20 per cent of GDP in 2016, compared with 12% of GDP at our November review.

We expect the contribution of domestic demand to real GDP growth to remain weak in 2016-2019 but for our assumed modest increase in oil prices to result in a more positive contribution from net exports. We estimate trend growth in real GDP per capita at negative 1 per cent, which is well below most economies at similar levels of development. We expect slow progress on the government’s Omanization program–a training program for Omani citizens aimed at easing dependency on foreign labour–due to a skills mismatch between many Omani workers in the private sector, and the more attractive pay and conditions that Omanis enjoy working in the public sector.

We estimate Oman’s budget deficit at 13 per cent of GDP in 2016, in line with the government’s own budget forecast. This compares with a deficit of close to 18 per cent of GDP in 2015. Oman increased its oil output to a record high of 358 million barrels of oil in 2015, a 4 per cent increase on the previous year, with exports rising by 5.5 per cent to 308 million barrels. However, this increase failed to effectively mitigate the negative ramifications from lower oil prices, with government oil revenues falling by about 40 per cent. Our general government balance forecasts include an estimate of the government investment returns.

In 2016, the government has indicated it plans to reduce spending, including subsidy expenditures, raise corporate taxes from 12 per cent to 16 per cent, and increase fees for government services. Spending is budgeted to fall 11 per cent compared with the 2015 outturn, with the largest cuts expected to come from “other” expenditures such as that on vehicle, travel, and hospitality expenses, followed by cuts to spending on civil ministries and investment.

Total revenues are budgeted to fall 4 per cent, as we expect the oil price to decline in 2016 compared with 2015. We understand that the 2016 budget is based on an oil price assumption of about $45/bbl compared with $75/bbl in 2015. Oman’s 2016-2020 five-year plan aims to increase the role of the private sector, and the government has suggested that it could privatize some entities in 2016. A value-added tax to be imposed across the Gulf Cooperation Council (GCC) could be in place by 2018, which would further support Omani government revenues. Our 2016-2019 general government deficit estimates are in line with those of the five-year plan.

We think that the government has relatively limited room for spending cuts, given that nearly 50 per cent of spending relates to public sector wages and subsidies and exemptions, which are typically difficult to reduce, although we note that some progress has been made with regard to subsidy reduction. The Omani government has committed to increasing non-hydrocarbon-related tax revenues over the medium term. As a result, we expect the general government deficit will average 11 per cent of GDP in 2016-2019. We assume that deficit financing will result in an annual average increase in Oman’s government debt of about 5 per cent of GDP a year over 2016-2019. We also estimate that the government’s net asset position will fall from 61 per cent of GDP in 2015 to 13 per cent in 2019.

Sizable oil receipts in past years have helped maintain Oman’s strong external position. However, lower oil prices lead us to forecast a current account deficit in 2016 of about 20 per cent of GDP, compared with 14 per cent of GDP in 2015. We expect the current account deficit will remain in double digits until 2019. Notwithstanding the related external borrowing and decline in foreign currency reserves, Oman’s external position–as measured by liquid external assets minus external debt–will remain a rating strength.

However, we expect it will deteriorate, to a debtor position of 25 per cent of current account receipts (CARs) in 2019 from a creditor position of about 60 per cent in 2015. Meanwhile, we expect the country’s gross external financing requirements will rise to 130 per cent of CARs and usable reserves in 2019 from 116 per cent in 2015.

In our view, monetary policy flexibility is limited because the Omani Rial is pegged to the U.S. dollar. That said, the peg has provided a stable nominal anchor for the economy, particularly as contracts for oil, the main export, are typically priced in dollars. Oman’s real effective exchange rate has appreciated by 12 per cent since early 2014. In our view, this represents a deterioration in international competitiveness of the country’s modest tradables sector, which is likely to dampen non-oil GDP growth, absent any offsetting factors, such as improved efficiency or technological capacity.

The transmission of monetary policy is constrained by an underdeveloped local capital market, although we expect to see some growth in local debt and sukuk issuance over the next four years. Nevertheless, we expect the peg to be maintained over the medium term. We estimate reserve coverage (including government external liquid assets) at 52 per cent of the monetary base and six months of current account payments in 2019. Rules of thumb for the adequacy of reserve coverage in relation to these measures are 20 per cent and three months, respectively.

We also consider the more qualitative aspects of the GCC currency arrangements. At a time of already significant change and regional geopolitical instability, politically conservative regimes such as the GCC are unlikely to decide to increase uncertainty about their economic stability by amending this fundamental macroeconomic policy. We expect these concerns will out-weigh the potential economic benefits of de-pegging.

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