Sunday 14, May 2017 by Nabilah Annuar

S&P Global Ratings lowers its rating on Oman to 'BB+/B' from 'BBB-/A-3'

The downgrade reflects S&P’s view that the Omani government's heightene   external financing needs have resulted in the economy's large net external asset position (external assets exceeding external liabilities) declining to a level insufficient to mitigate the risk from its volatile export revenue base.

S&P estimates that Oman's net external asset position has materially declined to 30 per cent of current account receipts in 2017, from 60 per cent in 2016. At the same time, they project that Oman's fiscal and current account deficits were higher in 2016 than we had anticipated, and GDP per capita lower. Based on their projections for continued sizable current account deficits, S&P expects Oman to be in a narrow net external debtor position of 12 per cent in 2020.

Due to oil prices remaining relatively low and Oman's dependence on the hydrocarbon sector for export receipts (60 per cent of total exports in 2016), large current account deficits above 10 per cent of GDP in 2017 and 2018 is expected, before they gradually decline to six  per cent of GDP in 2019 and 2020. The government is financing these current account deficits with a sharp increase in external debt, together with short-term private sector external borrowing. S&P estimates short-term external debt, of which two-thirds is from the financial sector and a third is from the nonfinancial private sector, at 60 per cent of current account receipts in 2016, up from 40 per cent in 2015.

Oman's external indebtedness is increasing rapidly because of large fiscal deficits. Gross general government debt is estimated to increase to 36 per cent of GDP in 2017, rising closer to 50 per cent by 2020. General government liquid assets is estimated at about 60 per cent of GDP in 2017, including government deposits at the central and commercial banks, alongside the government's investment funds, the largest component of which is the externally invested State General Reserve Fund. S&P also observes a sharp increase in the share of foreign currency and non-resident holdings of government debt from 17 per cent in 2015 to 68 per cent of total debt in 2016, predominantly held by non-resident investors. This weakening in the structure of the government's debt stock is currently mitigated by its net asset position; government liquid assets are estimated to exceed gross debt by 20 per cent of GDP in 2017 but are on a declining trend, which will result in a net debt position of about 4 per cent of GDP by 2020.

S&P’s forecasts for the annual average increase in general government debt remains very high, averaging at seven  per cent of GDP over 2017-2020. In the near term, the ratings agency expects the annual change in general government debt to be close to nine  per cent of GDP in 2017 while the fiscal deficit is estimated at 12 per cent, the difference being due to an expected draw down of government assets. The government is expected to maintain its stance of predominantly financing its deficits largely via the issuance of foreign currency debt. S&P expects that that fiscal consolidation will continue throughout our base case, supported by a combination of increasing revenues and contained expenditure growth over the medium term. Some of the revenue measures include raising the corporate tax rate to 15 per cent from 12 per cent, increasing fees for government services, and introducing a value-added tax in 2018 with other Gulf Cooperation Council (GCC) countries. The expenditure adjustments have included eliminating fuel subsidies and freezing wage increases, while reducing various benefits and bonuses for senior civil servants.

The Omani government's contingent liabilities is viewed as limited, including those related to the banking system. S&P classified Oman's banking sector in group 'five' under its Banking Industry Country Risk Assessment methodology, with group 'one' indicating the lowest risk and '10' the highest. It assesses the Omani banking system as largely funded by domestic customer deposits, while its reliance on external funding is increasing somewhat from a low base. We estimate short-term external debt from the financial sector at 40 per cent of current account receipts in 2016 compared to 27 per cent in 2015.

The Central Bank of Oman’s (CBO) gross reserve assets increased to $20 billion in 2016 compared with $17.5 billion in 2015. S&P expects them to remain at this level over the forecast period. Most of the reserve accumulation in 2016 related to non-resident deposits placed in the Omani banking system in 2015, which have since been transferred to the CBO as both a liability and an asset. Given the direct foreign claim on these assets, S&P subtracted them from their estimate of the CBO's usable reserves.

S&P estimates real GDP growth at 1.7 per cent in 2016. Our 2017-2020 forecast averages at two  per cent in the light of its oil price assumptions and continued government investment projects. However, in per capita terms, real GDP growth is well below peers, averaging -1.4 per cent (10-year average weighted as per our criteria) due to high and volatile population growth. Due to the economic concentration in the hydrocarbon sector, estimated at close to 30 per cent of GDP, Oman's economic performance remains vulnerable to oil prices, while the volume of oil production is likely to stagnate at around current levels. The agency’s GDP per capita estimate for 2017 is $15,700, which is expected t recover only slowly to about $17,000 in 2020, compared with $20,600 on average in 2011-2014, largely due to weak real growth and muted oil prices.

In S&P’s view, monetary policy flexibility is limited because the Omani rial is pegged to the US dollar. That said, the peg has provided a stable nominal anchor for the economy, particularly because contracts for oil, the main export, are typically priced in dollars. The transmission of monetary policy is constrained by Oman's underdeveloped domestic capital market, although we expect to see some growth in local debt and Sukuk issuance over the next four years. The peg is expected to be maintained over the medium term.

Under the rule of Sultan Qaboos bin Said Al Said, the country has undergone steady improvement in human development. Oman now ranks in the 70th percentile of countries in the United Nations Development programme's Human Development Index. Although this advancement stems largely from high hydrocarbon revenues during the sultan's reign, it also results from effective policymaking, with institutions such as the Consultative Assembly (Majlis Al Shura) and The Council of State (Majlis Al Dawla) involved in the decision-making process. Hover, the sultan exercises absolute por. While the Consultative Assembly representatives are democratically elected, all members of the Council of State are appointed directly by the Sultan, which can pose risks to the effectiveness and predictability of policymaking, said S&P.

The Sultan remains popular, but the eventual process of succession remains untested because the country lacks recent experience in smooth transitions of por. Although S&P expects that succession will be smooth, without any radical policy shifts, the possibility that Oman could experience a disruptive period of uncertainty if the royal family does not quickly agree on a successor cannot be ruled out. S&P does not anticipate that the conflict in neighbouring Yemen will spill over into Oman, which has remained neutral in the conflict.

S&P’s ratings on Oman are supported by its assumption that it could receive additional support from other GCC neighbours (Kuwait, Qatar, Saudi Arabia, and United Arab Emirates), in the event of further significant deterioration in its fiscal or external position.

The negative outlook reflects the potential for Oman's income level to aken and for its fiscal and external positions to deteriorate. S&P could consider loring the ratings if aker economic growth re to result in Oman's GDP per capita growing below its current expectations. The ratings agency could also lor the ratings on Oman if  observe increased external financing needs or a continued erosion of its external balance sheet, perhaps due to slippage in the fiscal consolidation path. Additionally, lor the ratings can be given if there are increasing signs of succession risks that re likely to disrupt governance standards or the functioning of institutions.

S&P could consider revising the outlook to stable if the foundations of economic growth in Oman strengthened, substantially raising per capita income levels; if Oman re to receive external financial support boosting useable reserves; or if our forecasts for Oman's fiscal and external positions improved substantially compared with our current projections.

Features & Analyses

Investment Banking Creating a diverse bond market

In an exclusive mini roundtable, Nabilah Annuar, Banker Middle East Editor, sits down with Michael Grifferty, President of the Gulf… read more