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COMMENTS

Credit FAQ: How Oman Could Weather Tough Funding Conditions Ahead


Credit FAQ: How Oman Could Weather Tough Funding Conditions Ahead

S&P Global Ratings recently lowered the ratings on Oman to 'BB-/B' and again assigned a negative outlook to reflect weak fiscal and external positions, exacerbated by lower oil prices, repercussions from the coronavirus pandemic, and capital outflows from emerging markets (see "Oman Downgraded To 'BB-' On Higher External Risks And Indebtedness; Outlook Negative," published on March 26, 2020).

In March, Oman's Eurobond yields spiked to distressed levels, with maturities of two to three years moving out by as much as 850 basis points (bps) to almost 12% within the month. We currently expect that funding conditions for Oman will improve in the second half of 2020 as global economic conditions gradually recover and oil prices track slowly rising demand.

In our baseline scenario, we expect the government of Oman will meet its sizable funding needs (including debt redemptions)--totaling almost $50 billion over 2020-2023--through external debt issuance (63%), drawdowns of domestic and external liquid assets (18.5%), domestic debt (15%), and other financial transactions (3.5%).

Nonetheless, if Oman were to consider the pricing of funding in international capital markets prohibitive or foreign investors were unwilling to roll over maturing debt, the country's depletion of external assets would accelerate, and confidence in the Omani rial's peg to the U.S. dollar could diminish. Our ratings on Oman are supported by our expectation that support from GCC countries would be forthcoming if the country were to experience significant external liquidity pressures, particularly those that could threaten the peg.

In our forecasts, we assume an average Brent oil price of $30 per barrel (/bbl) during the rest of 2020, $50/bbl in 2021, and $55/bbl from 2022, relative to $64/bbl in 2019 (see "S&P Global Ratings Cuts WTI And Brent Crude Oil Price Assumptions Amid Continued Near-Term Pressure," published March 19, 2020, on RatingsDirect). We also expect that Oman's economy will gradually recover after contracting by 4% this year. Here, S&P Global Ratings addresses frequently asked questions that we have received from investors following our rating action on Oman.

Frequently Asked Questions

What are the Omani government's funding needs?

Oman's fiscal deficits and maturing external and domestic debt will average slightly more than $12 billion annually over the next four years, or 17% of annual GDP, according to our forecasts.

Oman's political culture of consensus-driven policymaking has promoted social stability and gradual economic transformation. This deliberate consensus-building approach to fighting back against an external shock far more severe than the global financial crisis relies upon the country's access to foreign capital at reasonable rates. In the current context, this funding strategy is a vulnerability.

Oman (similar to some other oil-producing countries) enters into this confluence of events having made limited progress in diversifying its government revenue away from the hydrocarbon sector; oil and gas receipts make up about 75% of revenue. Its estimated fiscal break-even oil price is close to $90/bbl, the second highest in the GCC after Bahrain, according to the IMF.

Owing to a sharp drop in oil prices this year and oil production cuts under the recent OPEC+ agreement, we expect the central government fiscal deficit (excluding investment income on sovereign wealth fund assets) will rise to 17.5% of GDP in 2020 ($11 billion) from 9.7% in 2019 (see chart 1). Our 2020 deficit estimate incorporates realized privatization receipts from the sale of Oman Electricity Transmission Co. (OETC, BB-/Negative) of about $900 million or 1.4% of GDP, as well as spending cuts of 5%-10% across government departments, lower capital expenditure, and other contingency measures formulated by the national Tawazun fiscal program.

There could be some easing to liquidity pressures if the government succeeds in finalizing the privatization of Muscat Electricity Distribution Co. this year, which would generate proceeds estimated at about 1%-1.3% of GDP. However, we expect delays in the process due to the currently weak global economic environment.

Our 2021-2023 fiscal forecasts point to a gradual improvement in the fiscal deficit, reflecting a pickup in oil prices and the implementation of a phased medium-term fiscal plan, including the introduction of a 5% value-added tax planned for 2021.

However, in terms of funding needs, the relatively lower deficits from 2021 are partly offset by the large upcoming external debt redemptions of $4.3 billion 2021 and $6.4 billion in 2022. These principal payments include Eurobonds of $1.5 billion and $1 billion due in June 2021 and August 2022, respectively. The remaining amounts relate to a pre-export facility and a syndicated loan by several Chinese banks, most of which we expect will be rolled over.

Chart 1

image

How will Oman meet its funding requirements?

In line with trends since 2015, we expect the government will rely primarily on external debt to fund its fiscal deficits and seek to roll over maturing external debt. Between 2020 and 2023, we project the government will issue about $20 billion of new external debt and roll over about $11 billion of its $13 billion maturing external debt (see chart 2). The remaining funding needs will be met through drawdowns of government liquid assets and, to a lesser extent, issuance of domestic debt given shallow domestic capital markets.

Under our sovereign rating methodology, we consider flows and stocks of both debt and assets to assess a government's fiscal strength. Oman's net government debt will almost double to about 40% of GDP by 2023 relative to 2020, according to our forecasts.

We estimate that Oman's liquid assets stood at about $42 billion or 56% of GDP at end-2019. To calculate the country's liquid assets, we add government deposits in banks and the central bank and our estimate of the liquid portion of the external and domestic assets in the State General Reserve Fund (SGIF), Oman Investment Fund (OIF), and public pension funds. In our view, the government will aim to limit the depletion of assets considered as savings for future generations and therefore prefer to raise external debt instead. We also do not expect the government to draw significant amounts from its deposits in domestic banks of about $17 billion (one-third of total bank deposits), as it would increase liquidity pressures in the banking system. Excluding government deposits, liquid fiscal assets stood at $22 billion or 29% of GDP in 2019.

Chart 2

image

During 2020, we expect the government will fund its fiscal deficit of $11 billion and maturing debt of almost $3 billion mainly from external debt issuance of $6 billion, including syndicated loans from banks, bonds, sukuk, and some committed concessional loans from official lenders. The government will also withdraw an estimated $4 billion from the SGRF and OIF, with the remaining funded through domestic debt. We currently assume that the government will draw on proceeds from the sale of the Khazzan gas field of $1.7 billion that was assigned to Oman Oil Co. in 2019 as a cash transfer (labelled as 'Other' in chart 2).

We anticipate that external market conditions will improve in the second half of 2020, allowing Oman a window to start to issue commercial debt at lower rates than currently implied by bond yields. We note that Qatar, Abu Dhabi, Saudi Arabia, and even Bahrain (rated lower than Oman), were able to recently issue heavily oversubscribed Eurobonds of $10 billion, $7 billion, $7 billion, and $1 billion (with another $1 billion in sukuk), respectively. Nonetheless, we expect Oman will face a higher risk premium than in the past given the weakness in macroeconomic fundamentals, unless the government announces a substantial fiscal adjustment program or there is committed external donor support.

If market access does not improve during the rest of 2020, we expect the government will use the Petroleum Reserve Fund (PRF) to repay its $1.2 billion external debt redemptions. The PRF is a sinking fund available for debt repayment purposes and held assets of about $2.9 billion at year-end 2019, which form part of the central bank's gross foreign exchange reserves.

How could limited or impaired market access over a prolonged period affect Oman's external liquidity position?

If market conditions for Oman do not improve, the government may be forced to change its funding strategy and draw more extensively from its existing buffers. Below we outline two scenarios and their impact on Oman's external liquid assets. At end-2019, Oman had gross foreign exchange reserves of close to $17 billion (including PRF funds of $2.9 billion) and other government external liquid assets of about $16 billion, for a total of $33 billion.

For this exercise, we simplistically assume that the government's fiscal and monetary stance and the country's current account dynamics will remain as per our base case even when conditions starkly deteriorate, which we acknowledge is unlikely to be the case. We do not incorporate proceeds of future privatizations or monetization of state assets given the uncertainty regarding timing and amounts. We also assume the government will not draw on its bank deposits or issue more domestic debt than we currently forecast to limit pressures on the banking system.

Base case scenario.   The funding mix over 2020-2023 is as set out in chart 2. On a cumulative basis, external debt would cover 63%, drawdowns of domestic and external liquid assets 18.5%, domestic debt 15%, and one-off proceeds would cover 3.5%.

Scenario A.   The government is able to roll over maturing external debt of $14.3 between 2020 and 2023, but due to market conditions chooses to draw down its foreign assets rather than issue new external debt. The revised funding mix is as follows: external debt covers 29%, external liquid assets 43%, domestic liquid assets in the SGRF and OIF 10%, domestic debt 15%, and one-off proceeds would cover 3.5%.

Scenario B.   In the worst (highly unlikely) case, Oman is completely shut out of external debt markets until end-2023, which would result in a much faster depletion of foreign assets. This scenario entails 72% of funding needs met from government external liquid assets and foreign exchange reserves, with the residual funding coming from domestic liquid assets in the SGRF and OIF (10%), domestic debt (15%), and one-off proceeds (3.5%).

In our base case, we expect total liquid external assets to weaken slightly in 2020 and 2021, but remain largely stable on the back of external debt and foreign investment inflows (reflecting the OETC sale this year). Because of the debt-fueled financial account flows, however, the total economy's external debt metrics will continue to worsen. We project that external debt will exceed liquid external assets by 73% of current account receipts by 2023, up from 33% in 2019.

In scenario A, the drain on external liquid assets is heavier. We would expect these assets to decline by half over four years, reaching $16.4 billion at end-2023. The coverage of current account payments (CAPs) by gross external liquid assets (using a broader definition than usable reserves) would decline to 3.8 months from 7.6 months. While this coverage may be considered decent, it could increase pressure on the currency peg.

In scenario B, external liquid assets would drop to a perilously low level of $5 billion by end-2023. Under this hypothetical scenario, we would expect much weaker debt-servicing ability.

Chart 3

image

Can Oman sustain its currency peg?

Under our base case macroeconomic assumptions, we expect Oman will maintain sufficient foreign exchange reserves and other external liquid buffers to sustain the currency peg. In our calculation of Oman's usable reserves, we deduct the monetary base (and other encumbered assets) from gross foreign exchange reserves because coverage of the monetary base is generally seen as important to maintain confidence in the peg. We estimate Oman's usable reserves at $4.6 billion at end-2020 (compared with gross reserves of $14.8 billion), covering 1.2 months of CAPs. The "rule of thumb" typically used to estimate adequate reserve coverage is three months' of imports. Our measure of coverage that uses CAPs is more conservative. Oman's coverage would rise to 2.6 months of CAPs if government external liquid assets were also incorporated.

Sustained pressure on the balance of payments (for example, because of lower oil prices) could increase external risks. The external financing needs in Oman stem mainly from the government and, to a much smaller extent, from banks and corporates. In scenario B outlined above, Oman's gross foreign exchange reserves and liquid assets would no longer cover the monetary base by 2022. However, we note that some other regional sovereigns do not have full coverage of the monetary base. For example, Bahrain has only 60% coverage, but investor confidence is supported by backstop financing from its GCC neighbors.

Economic theory suggests that moving to a more flexible exchange rate allows the currency to act as a shock absorber during balance of payments crises and increases monetary policy flexibility via the interest rate channel. However, Oman's non-oil export base is small at about 18% of GDP, limiting the benefits of a more competitive exchange rate. At the same time, most of Oman's consumption consists of imported goods (similar to other GCC countries). The inflationary pressures and social costs of a devaluation could increase domestic political pressures. Moreover, Oman's government debt is 80% denominated in foreign currency, and a currency devaluation would further worsen public finances by increasing the value of foreign liabilities in local currency terms.

We note that the policy choice is not necessarily between a pegged and fully flexible exchange rate, should a pegged currency come under significant pressure. For example, crawling pegs, one-off or step devaluations, or the pegging of the domestic exchange rate to a basket of currencies, similar to the regime in Kuwait, could be among the various options.

What is the likelihood of external support for Oman?

In the event Oman's external reserves deteriorate significantly, we expect that financial support from neighboring GCC countries would be forthcoming. In our view, if one country's peg were to fall, the contagion effects could be severe for the rest of the GCC. We could see large deposit outflows from the region and rising dollarization, which could destabilize banking systems. Support for Oman could come in the form of deposits in the central bank to shore up reserves and support the peg or a loan package similar to that received by Bahrain, possibly with fiscal and foreign policy conditionality (see "Bahrain 'B+/B' Ratings Affirmed; Outlook Remains Stable," published on Nov. 30, 2018 on RatingsDirect).

If the duration of the global recession and coronavirus pandemic is longer than we expect, Oman could also consider an IMF support package to support a broader fiscal transformation program. However, we understand that the government is currently not exploring this option.

How does our credit view of Oman differ from that of Bahrain?

Bond yields and credit default swaps suggest higher credit risks in Oman than in Bahrain (B+/Stable/B), which we rate one notch lower. However, compared with Bahrain, we see Oman as having a stronger government balance sheet and external liquidity position. The gap in sovereign ratings between Oman and Bahrain was much larger in the past, but the rating on Oman has been inching closer to that on Bahrain. The negative outlook on Oman's rating implies a one-in-three chance that we could lower it to 'B+' over the next year, to the same level as Bahrain.

The negative outlook on the long-term 'BB-' rating on Oman reflects the risk that the government may be unable to moderate the continued rise in net debt levels, or that contingent liabilities from state-owned enterprises could materialize. We could also consider a negative rating action if we lowered our assessment of Oman's institutional capability to manage its public finances and achieve balanced economic growth. However, we could revise the outlook to stable if Oman's government under Sultan Haitham bin Tariq is able to inject new momentum into fiscal reforms and sustainably reduce government debt accumulation or if growth prospects improve significantly more than we currently expect.

Despite a stronger track record of GCC support for Bahrain than for Oman, we expect that both countries would receive further support from other GCC countries in the event of financial stress, and this provides additional support to our ratings.

Oman Selected Indicators
2014 2015 2016 2017 2018 2019 2020 2021 2022 2023
Economic indicators (%)
Nominal GDP (bil. LC) 31 26 25 27 30 29 24 27 29 30
Nominal GDP (bil. $) 81 69 65 71 79 76 63 69 75 79
GDP per capita (000s $) 20.2 16.6 14.8 15.5 17.2 16.5 13.8 15.2 16.3 17.1
Real GDP growth 1.5 4.6 5.1 0.3 1.8 1.0 (4) 2.0 2.2 2.2
Real GDP per capita growth (2.0) 0.5 (1.0) (2.9) 0.8 0.6 (2.7) 1.8 2.0 2.0
Real investment growth 2.4 (1.2) 16.5 (4.3) (5.1) 1.2 (12) 2.5 0.5 1.2
Investment/GDP 20.8 30.2 28.9 27.5 23.2 23.3 24.3 22.6 21.2 20.9
Savings/GDP 26.0 14.3 9.7 12.0 17.7 17.5 9 11.3 13.9 13.6
Exports/GDP 70.3 56.7 47.4 52.4 58.3 60.1 54.9 55.6 57.5 56.8
Real exports growth 0.1 (0.9) (1.9) (0.7) 12.7 2.0 (3) 0.5 2.2 2.1
Unemployment rate 3.8 3.5 3.3 3.1 1.8 2.8 3.5 3.0 2.8 2.8
External indicators (%)
Current account balance/GDP 5.2 (15.9) (19.1) (15.6) (5.5) (5.8) (15.6) (11.3) (7.3) (7.3)
Current account balance/CARs 7.3 (27.5) (39.2) (28.9) (9.2) (9.4) (27.3) (19.5) (12.4) (12.5)
CARs/GDP 71.7 57.7 48.9 53.8 59.7 61.9 57.2 57.7 59.5 58.6
Trade balance/GDP 31.8 13.2 9.6 12.4 22.8 23.2 16.0 19.0 22.3 22.4
Net FDI/GDP (0.1) (3.6) 2.9 0.7 7.1 2.4 3.8 2.5 2.5 2.4
Net portfolio equity inflow/GDP (1.3) 1.8 6.8 2.9 1.1 0.5 0.0 2.0 2.0 2.0
Gross external financing needs/CARs plus usable reserves 94.7 128.1 165.2 142.9 126.5 120.9 144.6 144.5 138.6 137.5
Narrow net external debt/CARs (80.9) (78.2) (17.0) 22.6 19.9 33.4 64.2 70.9 69.5 72.9
Narrow net external debt/CAPs (87.3) (61.3) (12.2) 17.6 18.2 30.6 50.5 59.3 61.8 64.8
Net external liabilities/CARs (73.1) (74.0) (20.7) 18.2 18.5 32.6 73.6 86.7 91.5 101.9
Net external liabilities/CAPs (78.8) (58.1) (14.8) 14.1 16.9 29.8 57.9 72.6 81.4 90.6
Short-term external debt by remaining maturity/CARs 16.8 25.5 45.3 39.5 32.7 32.0 43.5 41.6 37.7 37.6
Usable reserves/CAPs (months) 2.0 1.8 1.0 1.7 1.3 1.9 1.7 1.2 0.9 1.0
Usable reserves (mil. $) 7,736 3,730 6,773 5,775 7,968 6,509 4,609 3,683 4,203 4,787
Fiscal indicators (general government; %)
Balance/GDP (0.9) (17.5) (21.1) (13.9) (8.7) (9.1) (16.5) (11.3) (6.9) (6.5)
Change in net debt/GDP 4.6 22.3 34.6 16.2 4.9 6.6 13.9 11.3 6.9 6.5
Primary balance/GDP (0.7) (17.3) (20.5) (12.5) (6.7) (7.0) (12.6) (7.2) (2.6) (2.1)
Revenue/GDP 46.5 34.2 30.2 31.4 35.9 35.6 34.2 35.2 36.3 35.4
Expenditures/GDP 47.4 51.7 51.3 45.2 44.6 44.6 50.7 46.5 43.2 41.9
Interest/revenues 0.4 0.4 1.8 4.4 5.6 5.8 11.4 11.6 11.8 12.5
Debt/GDP 4.9 15.5 33.4 44.9 51.0 60.0 83.8 86.1 86.3 88.1
Debt/revenues 10.6 45.3 110.7 143.0 141.8 168.8 245.3 244.6 237.7 249.1
Net debt/GDP (68.6) (57.9) (26.3) (8.2) (2.4) 4.0 18.7 28.3 33.1 38.0
Liquid assets/GDP 73.5 73.4 59.8 53.0 53.4 56.0 65.1 57.8 53.1 50.1
Monetary indicators (%)
CPI growth 1.0 0.1 1.1 1.6 0.9 0.1 (0.5) 2.5 2.0 2.0
GDP deflator growth 1.2 (18.4) (9.6) 7.4 10.3 (4.9) (13.8) 8.0 5.4 2.8
Exchange rate, year-end (LC/$) 0.38 0.38 0.38 0.38 0.38 0.38 0.38 0.38 0.38 0.38
Banks' claims on resident non-gov't sector growth 14.8 12.3 9.4 6.8 6.3 (1.5) (1) 6.0 6.0 6.0
Banks' claims on resident non-gov't sector/GDP 57.1 75.0 86.4 85.6 81.0 83.1 99.4 95.6 94.1 95.0
Foreign currency share of claims by banks on residents 12.3 10.2 11.7 12.8 13.3 16.7 13 13.0 13.0 13.0
Foreign currency share of residents' bank deposits 11.6 12.4 11.7 11.1 15.1 12.3 15.0 15.0 15.0 15.0
Real effective exchange rate growth 1.3 10.7 0.8 0.1 (2.6) 1.6 N/A N/A N/A N/A
Sources: National Centre for Statistics Information, Ministry of Finance, and Central Bank of Oman (economic indicators); Central Bank of Oman (external indicators); Ministry of Finance and IMF (fiscal indicators); IMF, Central Bank of Oman, and Brugel (monetary indicators).
Adjustments: Usable reserves adjusted by subtracting monetary base and foreign assets placed by nonresidents at the Central Bank of Oman from reported international reserves. General government revenue adjusted by including investment incomes from sovereign wealth funds. Liquid assets include the liquid assets of the State General Reserve Fund, Oman Investment Fund, and public pension funds.
Definitions: Savings is defined as investment plus the current account surplus (deficit). Investment is defined as expenditure on capital goods, including plant, equipment, and housing, plus the change in inventories. Banks are other depository corporations other than the central bank, whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private- sector borrowings from nonresidents minus official reserves minus public-sector liquid assets held by nonresidents minus financial-sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. N/A--Not applicable. LC--Local currency. CARs--Current account receipts. FDI--Foreign direct investment. CAPs--Current account payments. e--Estimate. f--Forecast. The data and ratios above result from S&P Global Ratings' own calculations, drawing on national as well as international sources, reflecting S&P Global Ratings' independent view on the timeliness, coverage, accuracy, credibility, and usability of available information.

This report does not constitute a rating action.

Primary Credit Analyst:Zahabia S Gupta, Dubai (971) 4-372-7154;
zahabia.gupta@spglobal.com
Secondary Contacts:Trevor Cullinan, Dubai (971) 4-372-7113;
trevor.cullinan@spglobal.com
Dhruv Roy, Dubai (971) 4-372-7169;
dhruv.roy@spglobal.com

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