Looming Budget Crunch Pushes Oman Toward Debt Market

When Oman’s finance minister declared this month that the public sector wage bill might jump $2.3 billion next year – money which the government had not yet found – it was a fresh sign of a budget crunch looming in the Gulf state.

Government spending has been rising rapidly since 2011, when street protests demanding jobs and an end to corruption prompted authorities to boost welfare handouts. The government is also spending heavily in an attempt to diversify the economy before oil reserves start to run out.

Other Gulf Arab countries face the same social and economic pressures, but their oil resources are much larger and they have built up huge fiscal reserves that may allow them to spend their way out of trouble.

Oman, with a population of about 3.9 million, over a third of them foreign citizens, faces a tougher financial outlook in coming years. It may force the country to resume borrowing in international markets next year for the first time since 1997.

With the outstanding level of public debt still very low and the likelihood of support from diplomatic allies such as Saudi Arabia if needed, Oman does not face disaster. But the budget pressures may complicate the efforts of its 73-year-old ruler Sultan Qaboos, who has not publicly designated an heir, to keep social stability.

“We see a significant erosion in Oman’s public finances in the coming years, as oil revenues plateau and expenditure pressures remain high,” said Farouk Soussa, Citigroup’s chief economist for the region.

“The rate of expenditure growth in recent years has been alarming, particularly current expenditures, mainly wages and subsidies, which have risen by 122 percent in the two years between 2010 and 2012.”

OIL PRICE

Next year, state spending is expected to rise to a record OMR13.5 billion ($35 billion) from 12.9 billion planned for 2013, a draft of the government’s budget showed last week. But that is excluding the additional OMR800-900 million of wage costs which the government may have to pay following a royal order to standardise public sector salaries and grades.

Including that factor, overall budget expenditure could climb as much as 12 per cent to OMR14.4 billion next year, according to Reuters calculations. That would follow a 29 per cent jump in planned spending for 2013.

It is not clear exactly when Oman will start posting substantial state budget deficits, but the trend seems clear.

The International Monetary Fund predicted in October that Oman would slip into a fiscal deficit of 0.2 per cent of gross domestic product in 2015, widening gradually to as much as 7.1 per cent or about $6.8 billion in 2018 – but that was before the additional public wage expenditure was revealed.

Much will depend on global oil prices. They have remained at historically very high levels – Brent crude has averaged $109 a barrel so far this year – but any sustained drop into the $90s, perhaps due to renewed Iranian supplies to the world market if Tehran reaches a final agreement with world powers on its nuclear programme, would worsen the outlook for Oman.

One option for Oman in coming years will be to start running down its external assets to pay for domstic spending. Its two most prominent sovereign wealth funds are estimated by analysts to hold a total of about $16 billion worth of assets; the central bank’s foreign reserves stood at $16.1 billion, or 6.2 months of imports, in September.

“This is not a very strong level of backing when you compare this to SAMA’s (Saudi Arabian Monetary Agency) reserves, which are equivalent to about five years of imports,” said Giyas Gokkent, chief economist at National Bank of Abu Dhabi.

So an external borrowing programme looks likely to begin as soon as next year. Omani officials have said they are considering a U.S. dollar-denominated bond issue and may issue the country’s first sovereign Islamic bond, which could attract cash-rich Islamic funds from elsewhere in the Gulf.

Oman last tapped the international bond market with a $225 million eurobond in March 1997, when oil prices stood at around $20 a barrel. It sold the five-year bond at a small margin of just 73 basis points over U.S. Treasuries.

The country’s ratio of gross public debt to GDP stood at an extremely low level of six per cent in 2012, so it would probably not have trouble selling bonds. But all bets would be off if US monetary policy tightens next year, as many fear; this could hurt emerging market debt issues across the world.

POLICY

So Oman may have to start making difficult economic policy choices, and considering options from which it has so far shied away, as soon as next year.

Some of these options could in the long term help to promote private sector business and diversify the economy away from oil – but in the short term they could prove controversial, carrying political or economic risks.

Oman is already moving towards selling state assets; in September, the government revealed a plan to sell 19 per cent of top mobile telecommunications operator Omantel, which could raise $595 million, and in January it plans to release a list of state firms earmarked for sale.

“A successful privatisation policy would diversify fiscal revenues but also boost longer-term non-oil income by stimulating private sector activity,” said John Sfakianakis, chief investment strategist at MASIC, a Saudi investment firm.

Another policy under consideration is raising new taxes on Oman’s roughly 1.5 million foreign workers. By making employment of foreigners more expensive, this could cut unemployment among Omani citizens – but it would have to be handled carefully to avoid hurting the competitiveness of Oman’s economy.

Last week a committee of the Shura Council, a government advisory body, suggested that Oman should place a two per cent tax on the billions of dollars which foreign workers send back to their home countries every year.

“I promise that we will study this option, but we are worried that such a decision will affect the FDI (foreign direct investment) to Oman,” Financial Affairs Minister Darwish al-Balushi told a budget debate at the Shura Council this week.

So eventually, Oman may have to bite the bullet and cut spending in politically sensitive areas, such as state subsidies which keep down food and fuel prices. Balushi acknowledged that spending cuts might ultimately happen.

“In case we witness a decrease in revenues, we can cut expenditures, take loans or even use some of the reserve funds,” he said.

Oman may have less time than other Gulf states to decide between such options. In a report in June, multinational energy company BP forecast Oman’s reserves of 5.5 billion barrels of oil at end-2012 would last a little over 16 years at the current production rate.