Oman : a tiny sultanate that is not afraid to stand alone


The Sultanate of Oman is a founding member of the Gulf Cooperation Council (GCC), whose members tend to act in a concerted manner when taking strategic decisions. With regards to its foreign policy however,

Oman tends to balance the historical solidarity that links GCC members with its own desire to maintain good relations with all neighboring countries, including Iran. This provides Oman with strong political capital, which could play to its favour should it require financial support.
Oman has been governed by Sultan Qaboos bin Said Al Said since 1970. The Sultan is hugely popular and the country has seen steady improvements in human development under his reign. Being an absolute monarchy, executive powers are concentrated between the hands of the Sultan, with little place for sovereign institutions in decisionmaking.
The Sultan has reportedly faced heath concerns over the past few years, but has no publicly appointed successor. This poses risks to the predictability, sustainability and continuity of policymaking.

Since June 2014, Oman’s economy and public finances have suffered significantly from low oil prices. The country lacks the ample oil and fiscal reserves of its wealthy neighbours and its finances have been hit hard since the oil glut. With economic growth slowing, Oman now faces a twin deficit (fiscal deficit and current account deficit). This situation is the consequence of higher government spending compared to revenues coupled with higher imports than exports.

Conscious of the necessity to implement structural reforms, the Government has taken measures to shore up non-oil revenues in the coming years by launching a privatisation programme, increasing corporate income tax (from 12.5% to 15%) and eliminating a number of tax exemptions. It is also set to implement a value-added tax of 5% in 2018, in line with other GCC countries.
Authorities are also undertaking measures on the expenditure side, by cutting wages and benefits, reducing hiring in the public sector, gradually removing subsidies, increasing electricity tariffs, and limiting the launch of new infrastructure projects.

In addition, the freeze imposed on public sector hiring to curb fiscal deficits could trigger a resurgence of social discontent amongst its young and rapidly growing population.
In 2011 Oman responded to local protests by raising wages and creating tens of thousands of new jobs. As a result, fiscal expenditure rose by almost 35% that same year.
Should authorities face renewed rounds of social discontent in the current economic environment, the government is unlikely to have the same means at its disposal to restore order.

Until recently, non-hydrocarbon growth in Oman was largely driven by government projects, which generally tend to be postponed (or even shelved) when austerity measures are needed to counter lower fiscal revenues. The impact of the hiring freeze in the public sector, an increase in the cost of living, triggered to some extent by the removal of subsidies, and increased taxation, will negatively impact growth.

The 2016 budget was based on an oil price assumption of $45 a barrel; however, partly because oil averaged $39 last year, the deficit came in much higher than expected at about $13.7bn. Moving forward, other than restructuring the high dependency on oil through economic diversification, the country is planning to sell stakes in a string of state-owned companies over the coming years.
Following a revision of oil price forecasts, credit rating agencies heavily downgraded Oman’s sovereign credit ratings, based on their respective views of the Government’s financial position, in terms of fiscal buffers and flexibility and its ability to adjust to price-related shocks. Oman’s long term foreign currency rating currently stands at BBB-/negative (S&P), BBB/ stable (Moody’s).

The Omani economy lacks diversification and is largely reliant on hydrocarbons. Nonetheless, the government is planning to diversify through its Tanfeedh initiative, which was recently launched in collaboration with the Malaysian government.
The aim is to boost investment opportunities for the private sector in specific areas such as tourism, manufacturing, transportation, logistics, mining and fisheries, to eventually increase its contribution to economic growth, diversification and employment.

Oman and GCC countries’ currencies have been pegged to the US dollar (Kuwait is pegged to a dollar denominated basket of currencies) for nearly three decades and the dollar peg has provided a credible anchor of stability, reducing transactions costs and simplifying the conduct of macroeconomic policy.

The accumulation of current account surpluses over the years prior to the oil crash, allowed the Central Bank of Oman (CBO) to gather a considerable amount of foreign reserves, which stood at 30% of GDP at year-end 2016. These reserves are instrumental in supporting the peg in times of market turmoil. As the oil price reached new lows between June 2014 and June 2015, current account balances turned negative, and markets have occasionally challenged CBO capacity to defend the Omani Riyal’s Dollar peg, by betting on a devaluation of the Riyal. This consequently prompted the CBO’s decisive intervention to support the peg by insuring a firm and stable demand for its currency.
In this context, the decision in 2016 to substitute foreign debt issuance for sovereign asset drawdowns as the primary tool to fund budget deficits, supports CBO reserves and relaxes short-term pressures on the peg.
The Omani authorities have repeatedly argued against a change to the dollar peg, a position supported by the International Monetary Fund.
They point out that export and import price elasticities are exceedingly low and the potential impact on the trade balance would be marginal at best. Moreover, an adjustment after a long period of stability would be unsettling to markets and domestic repercussions could prove socially challenging. An alteration in exchange arrangements would also require close coordination with other GCC states, where a consensus could be difficult to reach.

Admittedly, the roots of the liquidity and exchange rate pressures are the large fiscal deficits and rigidities in the product and labour markets.
Hence, the policy focus at present should rightly be on ensuring that planned fiscal and structural reforms begin to yield results, in terms of improving the efficiency of resource allocation in the economy.
In this context, greater flexibility in the exchange rate could play an important role in supporting the reform process. To avoid unwanted volatility, the change need not be a sudden devaluation, but could take the form of a discrete shift to a basket of currencies, suitably structured to achieve, and then maintain competitiveness. Other options could be explored in due course.

Kinan Khadam-Al-Jame – Head Of Investments & Portfolio Management – Reyl Finance (Mea) Ltd.