Oman Outlook Revised To Negative On Rising External Risks; 'BB/B' Ratings Affirmed


Overview

  • We expect elevated fiscal and external deficits will lead to rising external debt over 2019-2022.
  • We are revising the outlook on Oman to negative from stable and affirming our 'BB/B' long- and short-term sovereign credit ratings.
  • The negative outlook reflects the risk that in the absence of substantial fiscal measures to curtail the government deficit, or a more favorable external environment, fiscal and external buffers will continue to erode.

Rating Action

On April 19, 2019, S&P Global Ratings revised the outlook on Oman to negative from stable.
At the same time, we affirmed the 'BB/B' long- and short-term foreign and local currency sovereign credit ratings on Oman.

Outlook

The negative outlook reflects our expectation that we could lower our ratings on Oman over the next 12 months if we view the government as unable to moderate external debt accumulation related to still-sizable fiscal deficits, which we expect will continue to increase through 2022.
We could also consider a downgrade if the government's funding costs increase beyond our expectations, or if funding pressures rise, with sizable external debt maturities currently scheduled for 2021 and 2022.
We could revise the outlook to stable if Oman is able to sustainably reduce its accumulation of external debt, for example through fiscal adjustment measures or via privatization of significant state-owned enterprises (SOEs) and assets. We could also revise the outlook to stable the ratings if economic growth prospects are significantly stronger than we currently anticipate.

Rationale

The sharp fall in oil prices over 2014-2016 and only modest recovery since then has caused a significant deterioration in Oman's GDP per capita and its fiscal and external metrics, similar to some other large oil exporters. The accumulation of government external debt has been a key factor behind negative rating actions on Oman. The government has made some strides toward diversification away from hydrocarbon receipts, but the pace and scope of planned fiscal measures could continue to be insufficient to stem deterioration in the government's balance sheet and curb rising external debt.
Our ratings on Oman are supported by the sovereign's modest government debt levels and relatively strong fiscal buffers, with liquid government assets estimated at about 50% of GDP. The ratings also reflect our view that timely support from neighboring countries in the Gulf Cooperation Council (GCC) would be forthcoming, if needed; for example, in the event of a significant deterioration in the external reserves that, in our view, support the Omani rial's peg to the U.S. dollar.
Our view of Oman's creditworthiness is constrained, however, by the concentrated nature of the economy–-Oman derives about 35% of GDP, 60% of exports, and 70% of fiscal receipts from hydrocarbon products. Given this high reliance on the hydrocarbon sector, we view Oman's economy as undiversified. We also view monetary policy flexibility as low, given the currency peg, although we note that it has provided a stable nominal anchor for the economy for several decades. The ratings are also constrained by our assessment that the sultanate's political institutions are at a nascent stage of development compared with those of nonregional peers in the same rating category.
Institutional and economic profile: Significant new gas production, along with non-oil sector prospects will support growth momentum
  • We expect rising oil and gas production and investment will drive real GDP growth of 3.1% on average over 2019-2022.
  • The country's institutions are relatively underdeveloped, in our view, with highly centralized decision-making and untested succession processes.
  • We expect Oman's foreign policy will remain neutral, and we expect limited spillover to Oman from regional geopolitical conflicts.
During 2018, increased gas production from the Khazzan field, recovery in the manufacturing sector, and higher crude oil production in the second half of the year supported real GDP growth of 3.4%, following a contraction of 0.9% in the previous year. In nominal terms, the hydrocarbon sector expanded by almost 37% year on year in 2018, largely on the back of higher oil prices. With a significant ramp-up in production, the gas sector's contribution has increased to about 20% of total petroleum activity, from 13% in 2015. The non-hydrocarbon sector also saw strong broad-based performance in sectors including manufacturing, particularly of base metals, trade, and financial services. However, a double-digit contraction in construction, partly due to completed megaprojects such as the new Muscat airport and several road projects, moderated overall non-oil sector growth to 0.9% last year.
We forecast real GDP growth averaging about 3% over 2019-2022. Although Oman is not a member of OPEC, in the past it has voluntarily participated in agreements by OPEC countries to limit oil production. We therefore expect crude oil production will remain stable this year at 2018 levels of 978,000 barrels per day (bpd), and thereafter gradually increase to close to 1.1 million bpd by 2022. We also assume that gas production will steadily expand in the medium term, in line with new production coming on stream with the Khazzan II and Mabrouk fields, among others. Higher gas production will in turn support the expansion of petrochemicals, power generation, and enhanced oil recovery projects. Non-hydrocarbon growth prospects could be supported by Oman's diversification strategy, with considerable investment in tourism, logistics, manufacturing, and renewable energy.
While Oman has relatively high GDP per capita levels, estimated at US$16,400 in 2019, real GDP per capita growth remains well below peers' at similar income levels. Including our growth forecasts through 2022, 10-year weighted-average real GDP per capita is expected to increase by about 0.4%. Population growth has historically been high due to immigration. However, we note that this has recently moderated due to the shrinking construction sector and the government's restrictions on expatriate labor in line with Omanization efforts.
Sultan Qaboos bin Said Al Said exercises absolute power and holds the offices of prime minister, chief of staff of the armed forces, minister of defense, finance, and foreign affairs, and chairperson of the board of governors of the Central Bank of Oman (CBO). The Council of Oman implements general state policies, and is split into the upper chamber (the state council) and the lower chamber (the consultative council). All members of the state council are appointed directly by the sultan, while the consultative council is democratically elected. In 2011, the sultan granted legislative and monitoring powers to the consultative council. The 78-year–old sultan has been in power since 1970. While the constitution specifies a process for choosing a designated successor, Oman's succession process is untested.
Geopolitical tensions in the region are likely to persist due to ongoing tensions between several GCC countries and Iran, and the boycott of Qatar by Saudi Arabia, the United Arab Emirates, Bahrain, and Egypt since June 2017. Oman has traditionally taken a largely neutral position in regional conflicts and continues to play the role of mediator. We note that regional tensions have increased trade activity in countries that have remained neutral in these disputes.
Flexibility and performance profile: Large fiscal and external deficits continue to erode Oman's external creditor and government asset positions
  • We expect fiscal deficits will remain at about 8.7% of GDP on average over the next four years, without additional fiscal adjustments relative to our base case.
  • Oman's large fiscal deficits require rising levels of external financing.
  • We expect Oman will maintain its currency peg in the medium term, supported by external buffers.
We assume Brent oil prices will average US$60 per barrel (/bbl) in 2019 and 2020, before falling to $55/bbl in 2021 and thereafter (see "Brent Crude Price Assumption For 2019 And 2020 Raised To $60 Per Barrel," published March 18, 2019, on RatingsDirect).
Supported by an increase in oil prices of 30% in 2018, we estimate that the fiscal deficit narrowed to a still-high 8.9% of GDP, from an average of more than 17% of GDP over the last three years. However, overall non-hydrocarbon revenue underperformed relative to budget targets despite higher corporate tax receipts, given hikes in income tax rates. At the same time, the government relaxed somewhat its stance on austerity. Current spending increased by more than 10% last year, partly due to increases in interest costs and electricity subsidies, following government spending cuts in 2016 and 2017. According to the authorities, this increase also reflects better recording of previous years' off-budget items. As a result, the deficit was higher than our initial estimate of 7.4% of GDP.
Given the predominance of hydrocarbon revenues, our forecasts for Oman's fiscal deficits are significantly affected by the trends in our oil price and production assumptions. We expect fiscal gains in 2019 from the implementation of excise taxes on cigarettes and energy drinks, and higher municipal service fees, along with a freeze on public sector hiring and stable capital expenditure. We anticipate that the implementation of the value-added tax (VAT), which has been postponed from its initial date of 2018, will begin in 2020. Further delays in implementation, along with a scenario of lower oil prices, pose downside risks to our assumption of narrower fiscal deficits relative to 2015-2017.
The government has announced its intention to slow the pace of borrowing in 2019. A significant portion of the deficit financing (more than 4% of GDP) this year is expected to come from one-off items, including proceeds from the sale of Oman Oil Co.'s stake of 10% in the Khazzan field to Petronas of Malaysia, sale of a gas pipeline from the government to SOE Oman Gas Company, and cash surplus from 2018. We understand that the government will continue to finance its deficits from 2020 predominantly via the issuance of foreign currency debt, with the remainder financed by asset drawdown, domestic debt, and asset monetization.
We forecast that Oman's annual average increase in net general government debt--which is our preferred fiscal metric, because in most cases it is more comprehensive than the reported fiscal deficit--will remain high, averaging 6.7% of GDP over 2020-2022. The government plans to privatize several SOEs in the coming years, starting with two companies in 2019--Oman Electricity Transmission Co. (BB/Stable/--) and Muscat Electricity Distribution Co. Additional foreign direct investment and revenue proceeds from these transactions would support the country's external position and government balance sheet.
Gross general government debt increased to an estimated 49% of GDP in 2018 from less than 5% in 2014, and we expect it will rise to about 64% by 2022. At the same time, the share of foreign currency denominated debt predominantly held by nonresidents increased to 80% of total debt in 2018, from 26% in 2015. In 2018, the government issued Eurobonds of US$6.5 billion in January and sukuk of US$1.5 billion in October. In our view, the debt structure is vulnerable to a sharp decline in foreign investor confidence in Oman, particularly as large Eurobond maturities loom in 2021 ($4.3 billion) and 2022 ($6.4 billion), which could add significant pressure to foreign exchange reserves. We note that authorities have transferred funds to the Petroleum Reserve Fund (PRF) for future debt repayment. The PRF held assets of about $1.2 billion at end-2018, which form part of the central bank's gross foreign reserves.
Oman's access to external funding is also becoming more costly, partly due to monetary tightening in the U.S. In the absence of material fiscal adjustment measures to stabilize the debt stock, we anticipate in our base case that interest costs as a percentage of revenue will continue to rise, but remain under 10% over the next four years.
High fiscal pressures since the drop in oil prices have eroded Oman's once-strong asset position, and we estimate that Oman will become a net debtor in 2019. We forecast general government liquid assets averaging about 48% of GDP over 2019-2022. In our calculation of assets, we include government deposits at the commercial banks and CBO, domestic and external liquid portion of the State General Reserve Fund (SGRF) and Oman Investment Fund, our estimate of the liquid portion of pension funds' assets, and government deposits abroad. We project an increase in net general government debt to about 20% in 2022 from -5% in 2018.
We estimate that the current account deficit decreased by 90% from the previous year, to 5.4% of GDP in 2018, primarily due to higher commodity prices but also due to the expansion of gas exports and non-oil exports. Over 2019-2022, we forecast that deficits averaging about 10% of GDP will lead to gross external financing needs of about 143% of current account receipts and usable reserves on average, higher than our previous projections. Although we expect a steady increase in gas production, we note that the majority will be required to meet the strong domestic demand rather than for exports. We expect, however, that the deterioration in the current account deficits will be curbed to some extent by growth in tourism and non-hydrocarbon exports including base metals, chemical products, and minerals.
For countries that operate with pegged exchange rate regimes, we deduct the monetary base from gross reserves, reducing usable reserves, as we view reserve coverage of the monetary base as critical to maintaining confidence in the peg. For Oman, we also subtract foreign assets placed by nonresidents from our estimate of the CBO's usable reserves, given the direct foreign claim on these assets. We do not include the government's fiscal savings in the SGRF as part of the CBO's usable reserves, in line with our treatment of other sovereigns' wealth funds managed outside of central banks.
Large external deficits turned Oman's net external creditor position (at the country level) to a net debtor in 2017. As a result of the large external financing needs, we expect that the country's external debt will exceed liquid external assets by an average of about 50% of current account receipts over the next four years.
We assess the Omani government's contingent liabilities as limited. However, we note that SOEs including Oman Refineries and Petrochemical Co., Oman Electricity Holding Co., Oman Oil Co., and Oman Air have ramped up external borrowing in recent years as direct government financial support has declined. Total SOE debt stood at 26% of GDP in 2018.
We classify Oman's banking sector in group '6' under our Banking Industry Country Risk Assessment methodology, with group '1' indicating the lowest risk and '10' the highest (see "Banking Industry Country Risk Assessment: Oman," published Feb. 19, 2019). We expect the ongoing price correction in the domestic property markets and high household debt levels will increase credit risks for Omani banks. We also continue to believe that systemwide funding may deteriorate if we see a significant weakness in government deposits, which account for more than one-third of the country's bank deposits. Nonetheless, banks remain well capitalized and have relatively limited reliance on external funding.

In our view, monetary policy flexibility is limited because the rial is pegged to the U.S. dollar. That said, the peg has provided a stable nominal anchor for the economy, particularly because contracts for oil, Oman's main export, are typically priced in dollars. We expect the peg will be maintained over the medium term. The transmission of monetary policy is constrained by Oman's underdeveloped capital market, although we view the recent commitment to build a local currency bond market as a positive development, supporting the growth of local debt and sukuk issuance over the next four years. The rise in interest rates in advanced markets also puts pressure on interest rates locally as the CBO refinancing rate maintains a consistent spread over LIBOR. Inflation has averaged under 1% over the five years to 2018. However, the implementation of tax measures, including excise taxes and VAT, could result in some modest inflationary pressure over the coming years.
We work across the world

From London to San Francisco, to our home base in (Saint Helier) Jersey, we’re looking for extraordinary and creative scientists to help us drive the field forward.

AC Investment Inc. currently does not act as an equities executing broker or route orders containing equities securities. If AC Invest’s business model were to change and it begins routing non-directed orders in NMS securities, it will comply with the disclosure requirement of Rule 606.

77 Massachusetts Avenue Cambridge, MA 02139 617-253-1000 pr@ademcetinkaya.com