Oman’s US dollar peg remains challenged by the large but narrowing twin deficits, said the Global Economic Weekly report published by Bank of America Merrill Lynch (BofAML).

“Delivering on budget targets is critical. This is particularly the case as the supply pipeline remains robust and as S&P could downgrade the rating to non-investment grade in May, weakening technical support for the bonds. We see no sign of imminent GCC support. Positively, political succession uncertainty could be easing,” said Mena economist Jean Michel-Saliba.

 Sustained external issuance needed to support the USD peg

Gross foreign assets of the CBO stood at RO7.2 billion ($17.8 billion) in February, down from RO7.8 billion ($20.3 billion) in December. FX reserves may have been impacted by the early repayment of the $1 billion Chinese loan that was due to expire in May 2017. FX reserves are likely to have been boosted in March by the proceeds of the $5 billion external sovereign bond issuance. RO0.5 billion ($1.3 billion) has already been withdrawn from the State General Reserve Fund (SGRF) for deficit financing purposes this year.

The CBO suggests that net reserves hover around $11 billion. This would exclude $5.5 billion in Iranian three-year sovereign deposits (non-usable due to restrictions) and $2 billion in deposits by the SGRF placed at the CBO in 2016 to support FX reserves. We expect the Iranian deposits to be fully redeemed over the coming years, thus likely increasing external financing needs. The potential merger between the SGRF and the Oman Investment Fund (OIF) is unlikely to lead to much in the way of investment synergies as the OIF's foreign assets are nearly depleted.

Authorities expect to tap the market for a $1-1.5 billion international sukuk by end-1H17. Authorities are mulling offering guarantees to facilitate external borrowing by Government-Related Entities (GREs). GREs are being encouraged to leverage up their balance sheets, while studies are in the preparatory stage for a potential listing of Oman Oil or its subsidiaries. In December 2016, the OIF acquired from the MoF a 51 per cent stake in Omantel for RO287 million, with RO-denominated proceeds earmarked for budget deficit financing. Further privatizations are being studied.

Our impression is that the authorities remain committed to the D peg given its costs and benefits. Our impression is that they also recognize that, beyond the debate, robust measures are needed to support the FX arrangement in the absence of a sustained and material increase in oil prices. Deposit dollarization in conventional banks remains in check at 11.7 per cent, but the large fiscal deficit continues to drive the external imbalances as the high FX leakages keep the current account deficit wide.

Fiscal could see improvement but in search of policy credibility

“We expect the fiscal deficit to narrow this year on the back of higher oil prices, but it is critical that authorities deliver on expenditure targets. Publication of a credible and well-articulated medium-term fiscal strategy could be helpful in this regard. Continued fiscal slippage is likely to negatively impact market access, particularly as the supply pipeline remains robust and the investment grade rating comes under pressure. We expect S&P to downgrade the rating to non-investment grade on 12 May,” said Michel-Saliba.

For now, authorities suggest that the consolidation focus is to remain on the current spending side (partly through some wage bill control thanks to a public sector hiring freeze, and the halt of all perks beyond regular payroll). A capex spending review is ongoing, but our impression is that sharp adjustments are unlikely so as to avoid a severe slowdown in the non-oil sector.

Part of the overspending in 2016 appears to be linked to payment of investment capex dues (RO225 million; $0.6 billion or 0.9 per cent of GDP) while there could be scope for further RO100 million ($0.3 billion or 0.4 per cent of GDP) in settlements this year. The disappointing non-oil revenue performance in 2016 was linked in part to the delay in enacting the legislation relevant to planned fiscal reforms. Authorities are guiding for the full year impact of the increase in the corporate tax rate from 12 per cent to 15 per cent to stand at RO100 million ($0.3 billion or 0.4 per cent of GDP).

However, the impact is more likely to appear in 2018 outturns when corporates settle taxes for tax year 2017. Authorities expect annual proceeds from implementation of the VAT from 1Q18 to stand at RO250-300 million ($0.8 billion or 1.1 per cent of GDP). A further RO400 million ($1.0 billion or 1.5 per cent of GDP) in additional revenues could accrue through various excise taxes, expat levies, real estate registration fee and municipality fees hikes. The municipality fee for all the tenancy agreements has been increased from 3 per cent to 5 per cent in February 2016 but there do not appear to be imminent plans to hike it further this year. OPEC cuts are already reflected in the 2017 budget.

An expat levy appears unlikely to be imposed for now, in our view. A proposal was floated in April 2016 to replace expatriates' visa renewal fees with a 3 per cent tax on income. However, authorities subsequently confirmed that there are no current plans for imposing expatriate income taxation or levying fees on expatriate outward remittances at the moment. Expatriate remittance fees are regressive in nature and may impact on private sector competitiveness. Also, they may encourage financial disintermediation and may conflict with compliance with the IMF Articles of Agreement stipulating that no restrictions be imposed on transfers and payments classified as current international transactions. An income tax on expatriate workers might reduce the country's attractiveness for labour migrants, especially with respect to other GCC countries.

Fiscal data for the first two months of 2017 show that the fiscal deficit stood at RO1.0 billion ($1.4 billion), compared to a full-year target of 2017 (excluding net grants) of RO3.0 billion ($7.8 billion and 11.9 per cent of GDP). Although revenues are showing early signs of improvement, there are no clear signs emerging yet of restraint on the expenditure side, in our view. Current spending has been boosted by defence and national security spending (up c40 per cent yoy) despite the budget guiding for lower defence spending. Investment spending is lower year-on-year but can be volatile month-on-month.

No imminent GCC support

The signature ‎of a Memorandum of Understanding between the Central Bank of Iran and the Central Bank of Oman (CBO), as well as the receipt of Iranian financial support, continues to weaken the chances of major GCC financial support, in our view. We are sceptical of the near-term success of any bailout talks in the absence of political concessions. Our impression is that Omani political authorities are also reluctant to go much further down this route despite some recent overtures towards Saudi Arabia. Still, Iranian promises of FDI appear to have disappointed.

That being said, we note that the Kuwait Fund for Arab Economic Development ‎has disbursed over the past two years a total of $1.2 billion in project support to Oman. This was part of the GCC $10 billion development fund set up after the Arab Spring and was disbursed directly to contractors. There have not been to date disbursements from the other countries that pledged support (Saudi Arabia, UAE and Qatar).

Political succession uncertainty eases

A front-runner to succeed Sultan Qaboos may have emerged. ‎In early March, Sultan Qaboos's 63-year old cousin, Asaad bin Tariq, was appointed as deputy prime minister for international relations and cooperation affairs, in addition to his role as the sultan's special representative. He went on since then to represent Oman at the Arab League Summit in Jordan. Asaad bin Tariq is now the second deputy prime minister, after Deputy Prime Minister for Cabinet Affairs of Oman Fahd bin Mahmoud Al Said, who has been in his post since June 1970.

While this could help reduce uncertainty about political succession, economic reforms are unlikely to be the main priority of a new sultan as he attempts to consolidate power in the early part of his reign. There is a risk of fiscal slippage after a transition, potentially through bonus wage payments. - TradeArabia News Service